Laws, Regulations & Annotations
Business Taxes Law Guide – Revision 2015
Sales and Use Tax Annotations
295.0000 GROSS RECEIPTS
295.0369 Liquidated Damages. XYZ Company enters into a supply contract to purchase tangible personal property from ABC Company. XYZ is obligated to purchase a minimum number of ABC's product per month at a set dollar amount per unit. The agreement stipulates that should XYZ fail to purchase the minimum number of units for a given month, XYZ is required to pay ABC a penalty amount as determined by a formula agreed to by both parties. ABC does not begin production of the units until it receives XYZ's monthly order form. Therefore, there is never an excess supply of units and XYZ cannot subsequently purchase units for which it was required to pay a penalty.
When the purchaser makes payments for damages to the retailer, the question becomes whether or not these payments are part of the gross receipts from the sale of tangible personal property. Inclusion of payments for damages in gross receipts depends on whether the damage payments are also a part of the consideration for the transfer of title or possession of the tangible personal property. If they are, absent a specific statutory exclusion from gross receipts or sales price, the damage payments are included in the measure of tax.
To the extent that the above supply agreement provides for damage payments to be made to ABC in the event of a breach of the agreement by XYZ, the agreement contains a liquidated damages clause. When XYZ makes a monthly purchase order for less than the minimum units required, this clause operates to increase the cost per unit because it increases ABC's retail selling price by the agreed-to penalty amount. Therefore, when XYZ places its monthly order it must take into consideration that it will cost more per unit to purchase fewer units than required under the agreement. As a consequence, the penalty amount set forth in the liquidated damages clause is part of the bargained-for consideration for the transfer of title to or possession of the units. Accordingly, when the purchaser breaches the agreement by not ordering enough units, the damage payment required by the agreement is included in the measure of tax as part of the gross receipts from the taxable sale of the units.
An exception to the above conclusion occurs when XYZ does not order any units in a particular month but is still required to pay damages to ABC. When there is no transfer of tangible personal property, the damage payment is not subject to tax. 8/26/03. (2004–2).