VAT Implications on Compensation for Price Adjustments in Construction Contract Disputes (Answer 215/2025)

Summary of Response No. 215/2025: VAT and Compensation Payments in Procurement Contracts

Subject: The inquiry addresses the VAT treatment of compensation payments made under a procurement contract.

Background:

The construction company “ALFA” entered into a contract with “BETA” for the construction of a new headquarters.
ALFA faced delays that led to additional costs, resulting in a court ruling that partially favored ALFA and ordered BETA to pay a compensation amount (excluding VAT).

Key Issues:

ALFA issued an invoice for the compensation without applying VAT, questioning the interpretive application of VAT regulations.
The company argues that the compensation is not subject to VAT because it does not involve the transfer of goods or services but is merely compensatory for damages due to delays.

Agency’s Opinion:

The Revenue Agency states that the legal nature of the payment determines its tax treatment.
Payments characterized as penalties or compensations for delays are generally outside the scope of VAT, as they do not represent consideration for services rendered.
However, the Agency notes that if the payment is tied to the procurement contract, it may be seen as an additional payment for services, thus subject to VAT.

Conclusion:

The Agency concludes that the compensation amounts due to ALFA for additional burdens are considered supplementary consideration related to the contract, making them subject to VAT.

This response highlights the complexities of VAT treatment in contractual contexts and emphasizes the importance of the nature of payments in determining tax liability.

Source: agenziaentrate.gov.it

UNOFFICIAL TRANSLATION

Response No. 215/2025
SUBJECT: VAT – amounts paid as price integration within a procurement contract

With the inquiry specified in the subject, the following QUESTION was presented:

The company “ALFA” (hereinafter “ALFA”, “Company”, “Applicant”, or “Taxpayer”) is a general construction company specialized in civil and hospital building, whose activities focus not only on the development of civil and hospital construction but also on the realization of infrastructure works, numerous road and railway works, urban development, and facilities management services.

The Company states that it has entered into a procurement contract (hereinafter referred to as the “Contract”) with BETA (hereinafter “BETA”) on …, concerning the execution of works related to a project that involved the construction of a new headquarters for BETA, located in the capital …. During the execution of the works related to the project, the Applicant experienced a series of delays in the continuation of the project, which was suspended multiple times. Due to these delays, the Applicant and the other companies in the contracting group sued BETA, requesting payment for the additional costs incurred during the execution of the contract.

The Court partially accepted the Company’s requests, condemning BETA, pursuant to Article 25 of the Ministerial Decree of April 19, 2000, No. 145, to pay the sum of euro … (hereinafter referred to as the “Compensation”), plus legal interest.

In detail, the Court recognized the Company’s complaints regarding the following reserves:
i. … relating to “greater direct and indirect burdens due to the delay attributable to the Contracting Authority in adopting the agreed variations, which were necessary to continue the works conveniently.”
ii. … relating to “greater direct and indirect burdens incurred by the Contractor” for the period between … and … following variations requested by BETA.

For the purposes of quantifying the damages, the Judge considered (a) the general expenses incurred by the Applicant, (b) the delayed receipt of business profit, (c) the depreciation of means, machinery, and equipment, and (d) the wages unnecessarily paid.

Following the issuance of the Judgment, BETA invited the Company to issue “the electronic invoices for the amounts as compensation (excluding VAT as per Article 15 of Presidential Decree No. 633/1972 and subsequent amendments) established by the Judgment…”.

Consequently, on …, ALFA issued an invoice to BETA without applying VAT for the amount recognized in the Judgment.

That said, in the Applicant’s opinion, there are currently interpretative doubts regarding the correct interpretation and application of the provisions of Article 3, paragraph 1 of the VAT Decree, insofar as it provides that amounts paid in fulfillment of obligations “to do, not to do, and to allow” are subject to VAT, and Article 15, paragraph 1, No. 1) of the VAT Decree, to the extent that it states that sums paid “as late payment interest or penalties for delays or other irregularities in fulfilling obligations of the assignee or the client” do not contribute to forming the taxable base.

According to the Company, it is necessary to assess whether the sums received by the damaged party are truly compensatory in nature, or whether they constitute consideration for an obligation assumed by the counterparty.

Finally, the Applicant does not see any precedents of similar practices to the case in question, as the Revenue Agency would have expressed itself only on cases where compensation is based on a contractual clause and not on a provision of a Judicial Authority.

INTERPRETIVE SOLUTION PROPOSED BY THE TAXPAYER
The Applicant believes that the Compensation due to the Company by virtue of the Judgment is “outside the scope” of VAT due to the fact that the objective requirement under Article 3, paragraph 1 of the VAT Decree is not met, as there is no transfer of goods or provision of services.

According to the Company, the applicability of VAT is provided where there is a consideration in exchange for the payment of a sum, that is, where there is a functional synallagmatic link between the aforementioned performances, as in the case of settlement agreements.

The Applicant emphasizes the difference in tax treatment between sums paid as compensation and those paid based on settlement agreements; the latter sums, according to practice, would be subject to VAT when they serve as “consideration” within a synallagmatic relationship. In support of this thesis, the Applicant cites several precedents such as responses No. 356 of May 19, 2021, No. 212 of April 22, 2022, and the recent response No. 33 of January 13, 2023, with which the Agency reiterated the VAT liability of sums paid in implementation of settlement agreements.

In the case at hand, according to the Applicant, the Company is not required to perform any service, but rather there is only an obligation, established by the Judge within the Judgment, for BETA to pay as mere compensation for damages.

In fact, the Judgment explicitly refers to Article 25 of Ministerial Decree No. 145 for the determination of the “how much” and “whether” of the damages suffered by the Applicant, which identifies the right of the contractor to recognition of damages suffered due to “unjustified” or illegitimate suspensions.

OPINION OF THE REVENUE AGENCY
This opinion is rendered based on the elements presented, assumed uncritically as illustrated in the inquiry, under the assumption of their truthfulness and concrete implementation of the content, without prejudice to any possibility of review and control by the tax administration.

That said, it is highlighted that the identification of the legal nature of the sums to be paid determines the correct tax treatment of the same. In particular, for VAT purposes, it is necessary to verify whether the sums to be paid represent consideration for a service received or compensation for non-fulfillment or irregularity in the fulfillment of contractual obligations.

According to Article 3, paragraph 1, of the Presidential Decree of October 26, 1972, No. 633, taxable service performances include “the provision of services against compensation dependent on contracts of work, procurement, transport, mandate, shipping, agency, mediation, deposit, and generally from obligations to do, not do, or allow, whatever the source.”

Article 13, paragraph 1, of Presidential Decree No. 633 of 1972 establishes that for VAT purposes “the taxable base of the transfers of goods and the provision of services is constituted by the total amount of the compensation due to the transferor or service provider according to the contractual conditions, including the burdens and expenses related to execution and debts or other charges to third parties assumed by the assignee or client…”

The subsequent Article 15, paragraph 1, No. 1) of the same Presidential Decree No. 633 of 1972 provides that sums due as “late payment interest or penalties for delays or other irregularities in fulfilling the obligations of the assignee or client” are excluded from the calculation of the taxable base.

For VAT liability, it is necessary to find performances characterized by the so-called reciprocity or synallagma. According to the constant orientation of the European judges, such reciprocity exists in the presence of a direct link between the service rendered and the countervalue received, where the sums paid constitute the effective consideration for an identifiable performance (in this sense, see CJEU case C-277/05 of July 18, 2007, as well as case C-270/09 judgment of December 16, 2010). The objective prerequisite for VAT application is lacking when no correlation between the operation carried out and the monetary payments is found.

Therefore, pursuant to Article 15, paragraph 1, of Presidential Decree No. 633 of 1972, amounts due exclusively as compensation, as well as for monetary revaluation on compensation for damages and related interests, are excluded from the scope of application of the tax.

Regarding the application of Article 15, paragraph 1, No. 1), the tax administration has emphasized that a strict prerequisite is “the existence of compensation in the proper sense, due to delays or non-fulfillment of contractual obligations” (see resolution June 3, 2005, No. 73/E). Furthermore, “sums paid as penalties for breach of contractual obligations do not constitute consideration for a service or transfer of goods but serve a punitive compensatory function. Consequently, these sums are excluded from the scope of application of the value-added tax for lack of the objective prerequisite” (see resolution April 23, 2004, No. 64/E).

In general, therefore, compensations, penalties, and indemnities serve to leave unharmed those who have suffered damage, delay, or loss. Conversely, it is the case of any additional compensation resulting from the receipt of sums that exceed the originally established consideration.

As for the case in question, if one were to limit oneself to the literal data of the judgment reported, where it speaks of “damage,” there would be no interpretative doubt, as the sums due as “penalties for delays or other irregularities in fulfilling obligations” constitute an operation outside the scope of VAT, pursuant to Article 15, paragraph 1, No. 1) of Presidential Decree 633/72.

However, it is necessary to value the circumstance that the sum of money that BETA must pay to ALFA is determined based on the delay suffered by the Applicant within an ongoing procurement contract. In particular, the sum for the greater burdens that BETA must pay to the Applicant due to the delays caused is contained within the procurement contract, which, based on what has been represented in the inquiry, has nonetheless concluded with the construction of the building for the client.

This leads one to believe that – regardless of the nomen iuris used by the Judge – this sum represents an integration of the consideration for the service provided to BETA, rather than a penalty.

In other words, the synallagmatic and not compensatory nature of the sum ordered by the Judge appears confirmed by the circumstance that – despite the delay suffered by the Applicant – BETA can nonetheless enjoy the new building.

In conclusion, in light of the observations specified above, it is believed that the sum to be paid to the Applicant, in relation to the “greater direct and indirect burdens” suffered, constitutes additional consideration compared to the original one, subject to VAT, in exchange for the execution of a performance, represented, in any case, by the procurement contract signed from which a compensation derives even if “exceeding” the originally agreed amount.

Signature on behalf of the Director of Large Taxpayers and International Affairs Fabio Ignaccolo
Delegation No. 9133 of September 18, 2023
THE HEAD OF THE SECTOR
(digitally signed)