Disputes on the VAT treatment of contract termination compensation

02.2015

The Spanish Supreme Court judgment of 27 April 2015 addressed the legal characterisation of compensation received by a real estate developer for early contract termination. The developer argued that the sum represented, on the one hand, a penalty clause and, on the other, compensation for lost profits — both elements being VAT exempt under established jurisprudence.

The Court disagreed. It held that not all amounts received upon contract termination due to breach should be considered non taxable compensation. Payments arising from breach of a lease with a purchase option (as a penalty clause) include amounts exceeding the original agreement. The difference must be split: part represents consideration for rental services rendered to that point, and part represents payment for the reacquisition of the unexercised purchase option. No amounts can be treated as lost profits or consequential damages, as these are already incorporated in the penalty clause. Only the agreed penalty clause itself remains exempt from VAT.

++ Published at the tax newsletter of the German Chamber of Commerce in Spain related to VAT news ++