Long-term contracts are the mainstay solution in public procurement procedures for large-scale infrastructure projects. Given the strategic nature and extended terms of contracts offered in these procedures, careful consideration should be given to the tax consequences that go with long-term contracts, which may depend to some extent on specific contractual provisions.

In practice, long-term contracts are based on a variety of formats. In Poland, an increasing number of infrastructure investments are based on the FIDIC Conditions of Contract, the international standard for construction contracts. The specifics of the FIDIC standard may have bearing on the timing of recognition of revenue earned and expenses incurred in the performance of long-term contracts.

The FIDIC standard

The FIDIC Standard Conditions of Contract, developed by the International Federation of Consulting Engineers (Fédération Internationale Des Ingénieurs-Conseils) in the 1990s and published in Poland by the Association of Engineering Consultants and Experts (SIDiR), are widely used throughout the world as a contract template in the construction and engineering sectors. In Poland too FIDIC has been growing in popularity over the past years, especially for large-scale construction projects such as road investments — the General Director for National Roads and Motorways (GDDiK) for one has long preferred this standard.

FIDIC contracts set contractual standard for various elements of a construction contracts — which, needless to say, may be modified as the parties to a given contract see fit — such as those relating to investment project management and distribution of risks and costs. Thus, the FIDIC Conditions of Contract can go a long way in facilitating relationship building among parties to an investment project.

Tax settlements — Revenue

When determining the right moment to recognize income (revenue) earned under a long-term contract, it is always crucial to identify the settlement rules agreed therein. What needs to be determined, in particular, is whether the parties to the contract have defined any accounting periods binding upon them. Also important in any contract (from both the formal and tax viewpoints) is what event the parties agreed will signal the successful performance of a service. Examples of such – widely approved in practice - events, relevant on the grounds of law (and hence also taxation), include delivery of requests for works inspections or acceptance of handing-over records.

In CIT settlements, the date of income earning by businesses providing services against payment is, as a rule, seen to coincide with the date of full or partial performance of a given service, with such income not to be recognized later than on the date of invoicing or payment of the amount due for the service.

Accounting periods

The contractual aspect is also important in correct determinations of the income (revenue) earning date from the tax perspective. Where the parties to a contract agree that service performance is to be settled within specific accounting periods, the last day of each accounting period specified in the contract or in an invoice issued is deemed the revenue recognition point (which must fall at least once a year).

Although no definitions were provided in the Corporate Income Tax Act of "services settled within accounting periods" or "partial performance of services," it is assumed that the term "accounting period" means a contractually defined recurring time interval, the lapse of which triggers the obligation to settle mutual financial obligations (with this to be any, quarterly or annual period, for example).

What must be borne in mind, however, is that it may not be enough for contracting parties to just formally indicate in their contract that they want services to be settled within a specific accounting period, such as a month, say. The position of the tax authorities here is that where some specific services are defined as services settled within a particular accounting period, it is key to have in the contract provisions regulating payment for services performed. In other words, the tax authorities may refuse to recognize a service as one settled within an accounting period, .e.g. if the contract explicitly provides for a single payment to be made for the service in advance.

Thus, where long-term contracts are concerned (including those based on the FIDIC standard), for a service to be classifiable as settled within accounting periods rather than as a partially rendered service, it always needs to be established whether or not the contract explicitly provides for settlements to be made within periods approved by the parties.

Services performed in stages

The situation is different for services performed in parts and settled in stages, based on the level of progress of work actually performed. The prevailing practice of the tax authorities confronted with long-term contracts — where no invoice has yet been issued or payment made — is to consider income from work performed to have been earned:

• on the date when the engineer issues the interim or final payment certificate in the case of FIDIC-based contracts; or
• on the date when the control inspector signs the partial or final works acceptance record (or an equivalent document provided for in the contract) in the case of other contracts.

That said, the tax authorities point out that if the final date of service performance completion cannot be established with certainty, they will rely on the date of invoicing the service (as when, for example, no date is put on the signed acceptance record).

It is important to keep in mind, however, that in the case of services settled within monthly accounting periods (e.g. by the last day of each month), the tax authorities also sometimes treat the date when the contracting authority executes the acceptance record as the date of income earning, as is the case with services settled in stages.

Advance payments

Not every payment received in a given accounting period must necessarily be recognized as the contractor’s income (revenue). It is universal practice to require advances for contract work that will not be performed until later accounting periods.

What tax authorities emphasize, however, is that a given payment may be deemed an advance (prepayment) towards a specific service due to be performed in some subsequent reporting period only if this follows from the contract made between the parties and is reflected in the relevant documentation. If, say, a given payment for construction materials is not in the nature of an advance payment, this income must be recognized at the end of the given accounting period / upon settlement of the relevant stage of work.

Thus, it is always worthwhile to consider how best to formulate the contractual provisions relevant to the adopted settlement model which, once approved by the other party, would make for simpler or uniform settlements on the part of the taxpayer.

Tax settlements — Costs

Tax authorities and administrative courts alike take the position that deductible (revenue earning) costs incurred in connection with the performance of long-term contracts should be accounted for in proportion to the income received in consideration of the performance of these contracts.

What this means is that taxpayers should recognize expenses incurred at the time of reporting the corresponding revenue from each completed stage of work performed, adopting an appropriate method of costs allocation to allow commensurate cost accounting. In this regard, it should be noted that the National Tax Information Service (Krajowa Informacja Skarbowa) in principle rightly approves in its interpretations some of the cost accounting methodologies proposed by taxpayers, such as those based on accounting principles.

Where costs are directly tied to revenue and incurred in subsequent tax years, these must be recognized in the tax year in which the revenue corresponding to them was earned. If, however, a direct cost is incurred after the date of the current financial statements (the deadline for filing the current tax return), i.e., already after a tax year has ended, it is deductible in the tax year following the year to which it relates.

At the same time, until the completion of the contract (when work is still in progress), the costs accounted for may not exceed the amount of the costs actually incurred, so that the methodology adopted does not violate the principle of actual cost incurred. In its interpretations, the National Tax Information Service likewise sees it important that these costs are not artificially inflated or understated, thus distorting the taxpayer's bottom line and, therefore, the reported income or loss figures.

Also, the tax authorities generally allow the cost of services performed by the time income generated by them was recognized to be classified as deductible costs even though the taxpayer has not received an invoice documenting these costs in the period for which the revenue is recognized. If that is the case, the taxpayer may recognize the (direct) cost of services rendered, incurred (as entered in the books) by the taxpayer during the period, based on the taxpayer's internal accounting documents, such as account notes.

Increased remuneration

Pursuant to Article 439(1) of the Public Procurement Law Act of 11 September 2019, all contracts for works, supplies or services concluded for periods of more than six months should provide mechanisms for adjusting the amount of remuneration due to the contractors in the event of changes in the prices of materials or the costs of performing their contracts.

The FIDIC Conditions of Contract in principle provide for mechanisms of adjusting the amount of remuneration due to the contractor on an ongoing basis (indexation). If these mechanisms are applied, the increased income should also be recognized on an ongoing basis for taxation purposes, in line with the rules discussed in the first part of this article.

Starting from 1 January 2016, indexation of remuneration relating to past periods — if not necessitated by an accounting error or some other obvious mistake — is made on an ongoing basis, i.e., in the accounting period in which the correcting invoice was issued or, in the absence of an invoice, another document warranting the adjustment.

The above applies analogously to the recognition of income received when a court orders contractual remuneration to be increased.

Some consequences of remuneration adjustments in the course of contracts that may not be immediately obvious are also worth keeping in mind. Depending on the circumstances, an increase in remuneration may sometimes also result in a change in profitability, the level of which will be relevant to identifying possible obligations relating to mandatory minimum corporate income tax payments (in practice, the regulations governing this minimum tax have been suspended until 1 January 2024).

This tax, constituting 10 percent of the tax base (calculated as the sum of a certain percentage of operating income and certain types of expenses) must be paid by companies and tax capital groups which in the given tax year have either incurred a loss from a source of income other than capital gains or have received income from such sources amounting to no more than two percent of their revenue. Thus, in some cases indexation serving as a mechanism for safeguarding the contractor’ interest may help maintain an adequate level of profitability and thus avoid the minimum income tax.

In addition, indexation of remuneration (whether contractual or court-ordered) may significantly impact EBITDA, thereby also impacting the level of limitation of debt financing costs classifiable as deductible costs.

The authors’ view

Given the complex nature of long-term public procurement contracts, they must always be reviewed from the tax perspective, particularly with regard to corporate income tax. You can avoid negative consequences in the future if you review a contract thoroughly before executing it or look closely at a contract model (such as one based on the FIDIC standard) before adopting it in your company.