Liquidated damages refer to money or other properties that the delinquent party should pay to the other party according to the mutual agreement or legal provisions. Liquidated damages can guarantee the performance of the liabilities, punish the delinquent party and compensate the loss of the no fault party.

1. After the performance of the contract, liquidated damages collected due to the buyer’s deferred payment  
   
   According to Provisional Regulations on VAT, enterprises and individuals who sell goods, provide process and repair labour services, sell services, intangible assets, fixed assets and import goods in China shall be the taxpayers of VAT. The taxable sales shall be the total price and extra charges, including handling charges, subsidies, funds, capital raising expenses, returned profits, incentive fees, liquidated damages, overdue payments, deferred interests, compensation, withholding payments, packaging fees, packaging rental, storage fees, quality fees, transportation fees and other charges.
   
   After the performance of the contract, liquidated damages paid by the buyer due to deferred payment composes extra charges, the seller is required to pay VAT and CIT.
   
   
2. The sales contract cancelled after signing, liquidated damages collected due to the buyer’s breach of the contract
   
   According to Provisional Regulations on VAT, the taxable sales shall be the total price and extra charges. If the contract is terminated before the performance just because of the buyer’s breach of the contract, then the taxable sales does not occur. Therefore, the seller shall not pay VAT for the liquidated damages collected from the buyer, but need to pay CIT.
   
   
3. Liquidated damages paid to the buyer by the seller
   
   According to Provisional Regulations on VAT, the taxable sales shall be the total price and extra charges, which means the charges are collected from the buyer but not from the seller. Therefore, liquidated damages paid by the seller does not form extra charges, the buyer should pay CIT instead of VAT.
   
   
4. Liquidated damages obtained from individual’s equity transfer
   
   According to Individual Income Tax Law, after the successful equity transfer, liquidated damages obtained by the transferor due to the transferee’s failure to pay price within the prescribed time limit comprises income of property transfer. The transferor shall combine the liquidated damages with the transfer income and pay individual income tax.
   
   
5. Liquidated damages obtained by enterprises
   
   According to Corporate Income Tax Law, gross revenue obtained in various sources shall be the total amount of income, both monetary and non-monetary. Gross revenue include income from selling goods, providing services, transferring properties, dividend and other equity investment income, interest income, rental income, royalty income, donation income and other income. Therefore, enterprises should pay corporate income tax for the liquidated damages income.
   
   
6. Liquidated damages obtained from employees leaving before the expiration of labour contract
   
   According to Provisional Regulations on VAT, enterprises and individuals who sell goods, provide process and repair labour services, sell services, intangible assets, fixed assets and import goods in China shall be the taxpayers of VAT.  Employees leave the company in breach of the labour contract is not a violation of sales contract. Therefore, enterprises shall pay CIT instead of VAT for liquidated damages income.