Contract penalties and compensation in Vietnam: getting VAT, CIT, foreign contractor tax and invoicing right

The short answer

The party receiving a penalty or compensation in cash:

• does not issue an invoice;

• does not declare or pay VAT on it;

• simply issues a receipt in accordance with the rules;

• records it as other income, subject to CIT.

A party compensating in goods or services: must issue an invoice and declare VAT as for an ordinary sale.

The party paying a contractual penalty: the payment may be deductible if it has a contractual basis and complete documentation. This differs from administrative fines, which are never deductible.

The most common mistake: deducting the penalty directly from the invoice value. The sales invoice must still show the full value of the goods or services supplied. The penalty is handled through separate documents.

Why does this "small" topic cause so many disputes?

Penalties and damages appear in almost every commercial contract: late delivery, late payment, defective goods, early termination. Each sits at the intersection of three areas: contract law, accounting and tax.

Getting one area wrong usually means getting the other two wrong as well. For example, recording a penalty as a revenue reduction rather than other income misstates both VAT and the invoice.

Quick reference: tax treatment by scenario

Scenario	Invoice	VAT	CIT
Penalty or compensation received in cash	No invoice, receipt only	Not declared or paid	Other income of the recipient
Contractual penalty or compensation paid in cash	Payer issues a payment voucher	Not applicable	Deductible if properly supported
Compensation in goods or services	The compensating party issues an invoice	Declared as a sale; recipient credits as provided	Recorded according to substance
Late-payment interest received	No invoice	Not subject to VAT	Financial income
Administrative fines imposed by the State	Not applicable	Not applicable	Not deductible for CIT

Where a business both receives and pays penalties under the same contract, they may be offset. The net amount is recorded as other income or a reduction of other income.

Four common traps

1. Deducting the penalty on the invoice. This is the most common error. The buyer penalises the seller for late delivery and deducts the penalty from the payment. The seller then issues an invoice net of the penalty. This is wrong:

• revenue and output VAT are under-declared;

• the buyer's input VAT credit does not reflect the substance of the transaction.

The correct approach is for the seller to invoice the full value of the goods. The buyer issues a receipt for the penalty, and the parties settle on a net basis.

2. Confusing penalties with price reductions or discounts. A price reduction for defective goods, or a trade discount for volume targets, is a price adjustment that must appear on the invoice. A penalty is a sanction for breach of an obligation, not a price adjustment. The contract wording must reflect the true substance. In a dispute, the tax authority looks at substance, not labels.

3. Penalties above the statutory cap. For commercial contracts, the Commercial Law caps penalties at 8% of the value of the breached obligation. Construction contracts have their own cap. Any penalty above the cap may be legally ineffective. This affects not only the right to collect, but may also lead the tax authority to question whether the expense paid was justified.

4. Overlooking foreign contractor tax when the counterparty is foreign. Where a Vietnamese business pays penalties or compensation to a foreign contractor in connection with a contract for services in Vietnam, foreign contractor tax must be assessed. Under current guidance, penalties and compensation received by a foreign contractor are generally included in its CIT-taxable revenue but are not subject to VAT. Each case should be reviewed before payment.

Documents needed for a penalty to stand up for tax purposes

• The contract, with clear penalty and damages clauses: grounds, amounts and method of calculation.

• Minutes confirming the breach, or a breach notice and the breaching party's response.

• A penalty notice or damages claim with a specific calculation.

• Receipts, payment vouchers or a netting agreement.

• Accounting entries reflecting the substance: other income or other expenses, not a revenue reduction.

Illustrative case

Company Q is a construction contractor for a project owner. The final payment instalment is VND 5 billion (excluding VAT). Because of delays, the owner imposes a VND 300 million penalty under the contract.

The wrong way:

• Q invoices VND 4.7 billion (net of the penalty), with VAT of VND 470 million.

• Result: revenue and output VAT are under-declared by VND 300 million and VND 30 million respectively.

• In an audit, Q faces collection of the shortfall, late-payment interest and possible penalties. The owner must also adjust its input VAT.

The right way:

• Q invoices VND 5 billion plus VAT of VND 500 million, VND 5.5 billion in total.

• The owner issues a receipt for the VND 300 million penalty and records it as other income.

• The parties sign a netting agreement, and the owner actually pays VND 5.2 billion.

• Q records the VND 300 million as an other expense. It is deductible for CIT because it is supported by the contract, breach minutes and complete documentation.

FAQs

Must an invoice be issued for a contract penalty received?

No, if it is received in cash. The recipient issues only a receipt, does not declare VAT, and records the amount as other income subject to CIT.

Is a contractual penalty paid to a counterparty deductible?

It may be, if the penalty has a contractual basis, a confirmed breach and payment records. Administrative fines imposed by state authorities are not deductible.

How is compensation in goods treated?

The compensating party must issue an invoice and declare VAT as for a sale of goods. The recipient declares and credits as provided by law.

What is the maximum contractual penalty?

For commercial contracts, 8% of the value of the breached obligation under the Commercial Law. Civil and construction contracts follow their own rules.

Legal basis

• Civil Code 2015 (Article 418 on contractual penalties).

• Commercial Law 2005 (Articles 301 and 302 on penalties and damages).

• VAT Law No. 48/2024/QH15 and Decree No. 181/2025/ND-CP (cases in which VAT need not be declared or paid).

• CIT Law No. 67/2025/QH15 and Decree No. 320/2025/ND-CP.

• Decree No. 254/2026/ND-CP on invoices and e-documents; current rules on foreign contractor tax.

How W&A can help

Penalty and damages clauses need to be designed with law, accounting and tax in mind at the same time. With contract lawyers and tax specialists on one platform, W&A supports businesses with:

• Drafting and reviewing penalty and damages clauses: within statutory limits, enforceable and clear for tax purposes.

• Tax and invoicing advice on each penalty, compensation and netting arrangement.

• Foreign contractor tax review on penalties and compensation paid to foreign counterparties.

• Recovery of penalties and damages through negotiation, mediation, arbitration and litigation.

• Support with explanations when the tax authority examines receipts and payments arising from contract breaches.