4 – Tax treatment of non-performing receivables and their sale

This analysis focuses on the tax consequences of accounts receivable becoming non-performing and the sale of such accounts receivable. Since these receivables arise from commercial transactions, the Serbian tax system looks at them only from the perspective of corporate income tax (CIT) and value added tax (VAT). Serbian tax laws contain detailed provisions on the recognition of accounts receivable as expenditures for tax purposes and the tax treatment of the sale of these receivables. The review here aims at revealing the tax benefits the assignor and assignee can make use of in these situations, the taxes and other costs payable pursuant to tax rules, and a number of statutory constraints that can adversely affect the sale of receivables in Serbia.

TAX TREATMENT OF NON-PERFORMING RECEIVABLES

A non-performing receivable is one: 1) whose collectability, either in whole or in part, is doubtful; or 2) which is certain to be uncollectable either in whole or in part. In the former case, where collectability is questionable, the creditor may impair the receivable to reduce the carrying value to its appraised face value. In the latter situation, where the receivable is certain to remain outstanding, the creditor may write it off.

Valuation of accounts receivable is governed by the Regulation on recognition, valuation, presentation, and disclosure of positions in individual financial statements of micro and other legal entities.^[1] Short-term receivables are valued at their face value reduced indirectly by the estimated amount of the receivable likely to remain uncollected, or directly in the event that inability to collect is certain and documented (Art. 29[6] of the Regulation).

Receivables as tax expenditures from the perspective of CIT rules

Impairment loss and outright write-off of receivables are expenditures recognised in tax balance sheets for the purposes of CIT assessment, according to rules set out in the CIT Law. Recognition of impairment losses and write-offs as tax expenditures is regulated by Article 16 CIT Law (except for commercial banks, which are subject to Art. 22a CIT Law). For a taxpayer to account for a particular receivable as an expenditure in its tax balance sheet, it must meet the requirements of the CIT Law, otherwise it has to include the non-performing receivable in its taxable income. These considerations require identifying when a taxpayer may impair a receivable and when it is able to write it off for the purpose of assessing its CIT taxable base.

Write-off of receivables

A taxpayer may write off non-performing receivables and present them as expenditures for the purpose of assessing its CIT taxable base under the following requirements set out in Article 16[1] of the CIT Law:^[2]

1. there must be unambiguous evidence that the receivables were previously included in the taxpayer’s income;
2. the receivables must have been written off as uncollectable in the taxpayer’s books of account; and
3. the taxpayer must provide evidence of having sought to collect the receivable in court, meaning that enforcement proceedings were initiated to collect the receivables or that the receivables have been filed as claims in a liquidation or bankruptcy proceeding against the debtor.

The creditor must meet these requirements cumulatively or the written-off receivable will not be recognised as a tax expenditure. It follows that the creditor must pay the costs of legal actions undertaken to collect the receivable (costs of litigation against the debtor, initiation of enforcement proceedings, and the like) for the write-off to be recognised as a tax expenditure.^[3] The CIT Law also envisages three exemptions where the creditor need not take legal action to collect: 1) if the receivable is included in a financial reorganisation effort within the meaning of the law governing consensual corporate financial restructuring; 2) if the receivable is included in a pre-packaged reorganisation plan confirmed by a final procedural decision adopted pursuant to the BL; and 3) if the costs of actions required to collect receivables from one debtor exceed the total value of the receivables owed by that debtor.

Impairment of receivables

A creditor may impair a receivable and present it as an expenditure in its tax balance sheet if the receivable is at least 60 days past due at the end of the tax period. However, the creditor must meet the requirements of Article 16[1] and [2] of the CIT Law in the tax period in which the (impaired) receivable is written off for the impairment loss to be permanently recognised as tax expenditure.^[4]

As envisaged by Article 16[10] CIT Law, all receivables that have been written off and impaired and other receivables referred to in Article 16 recognised as expenditures that are subsequently collected, or that are subject to lawsuits, enforcement motions, or claims in bankruptcy that are subsequently abandoned by the creditor, will be deemed to have become income of the taxpayer at the time they are collected or the action is abandoned.

The above considerations suggest that the creditor is always required to pay the costs of actions to collect any receivables impaired or written off that have been recognised as tax expenditures. Otherwise, the creditor will be required to include the impaired and/or written-off receivables in its CIT taxable base. These costs may induce the creditor to assign some non-performing receivables at a discount instead of writing them off. These could be debts owed by insolvent debtors where the creditor does not expect to be able to enforce its debts quickly and efficiently. Additional incentives for assignment of non-performing receivables are described in the section of this study dealing with the treatment of assignment for CIT purposes.

CIT RELIEF RULES IN OTHER JURISDICTIONS

The discussion above suggests that Serbian taxpayers (that are creditors) are required to pay the costs of proceedings to collect non-performing receivables, and many countries in the region have similar arrangements in place. However, in some jurisdictions, creditors have access to alternatives that do not require other actions. For instance, in Croatia, impairment of accounts receivable for goods and services is recognised as a tax expenditure if it is more than 60 days past due at the end of the tax period and has not been collected for 15 days before the tax return is filed. Impaired receivables accounted for as recognised tax expenditures in previous tax periods are included in income if the creditor has not met the necessary requirements before the entitlement to collect has lapsed due to statute of limitations. The requirements for recognising impairment loss are: 1) the receivable must be presented in the creditor’s books of account as income; and 2) due diligence must have been exercised in taking action to recover the debt. Due diligence is deemed to have been exercised where the creditor has: a) taken legal action or initiated an enforcement proceeding to collect the account receivable; b) filed a claim for the receivables in a bankruptcy proceeding; or c) reached settlement with the debtor, which must not be an affiliate of the creditor, within the meaning of regulations governing bankruptcy, arbitration, and conciliation.^[5] As such, Croatian taxpayers may impair receivables even where they have taken no legal action to collect them or moved to enforce but have instead agreed payment terms in a separate legal proceeding that allow the taxpayer to recover less than the total value of the receivable. In Montenegro, Federation of Bosnia and Herzegovina, and Republika Srpska, requirements for recognising impairment losses and write-offs are stricter than in Serbia, as there a receivable must be more than one year past due to be impaired or written off (under the Serbian CIT Law, a receivable has to be at least 60 days past due at the end of the tax period for impairment loss to be recognised). The Montenegrin Corporate Income Tax Law stipulates that impairment loss or write-off of a doubtful receivable can be recognised as a tax expenditure if: 1) it is proven beyond doubt that the receivable was previously included in the taxpayer’s income; 2) the receivable is written off as uncollectable in the taxpayer’s books of account; 3) the taxpayer produces evidence of having taken legal action to collect or enforce the receivable or having filed the relevant claim in a liquidation or bankruptcy proceeding against the debtor; and 4) the account receivable is more than 365 days past due.^[6] The Federation of Bosnia and Herzegovina imposes similar requirements: 1) the receivable must have been included in the taxpayer’s income in the previous tax period and must be more than 12 months past due; or 2) legal action must have been taken to collect the receivable or the relevant claim must have been filed in a liquidation or bankruptcy proceeding against the debtor.^[7] The Republika Srpska recognises impairment losses as tax expenditures if the impaired doubtful receivable for goods and services was previously included as income in the taxpayer’s taxable base as follows: 1) up to 25 percent of the value of a receivable more than 12 months past due; 2) up to 50 percent of the value of a receivable more than 18 months past due; and 3) up to 75 percent of the value of a receivable more than 24 months past due. One exception to this rule are doubtful receivables more than 12 months past due where the creditor has taken at least one of the following actions to collect: 1) taken legal action to collect; 2) filed an enforcement motion with the relevant court; 3) initiated enforced collection; 4) filed the relevant claim in a bankruptcy proceeding against the debtor; or 5) reached agreement with the debtor in a liquidation or bankruptcy proceeding.^[8]

NON-PERFORMING RECEIVABLES FROM THE PERSPECTIVE OF VAT

Pursuant to the Value Added Tax Law, for every VAT taxable transaction involving goods or services, a VAT payer must assess and account for VAT. The VAT indicated by a creditor in its invoices constitutes its tax liability it is required to assess, report, and pay. Under Article 16 of the VAT Law, a tax liability arises on the earliest date of any of the following actions: 1) transaction involving goods or services; 2) collection or payment, where all or part of the consideration is collected or paid in cash prior to a transaction involving goods or services; 3) issuance of invoice for services of transfer, assignment, and use of copyright and related rights, patents, licences, and trademarks, and time-limited technical support services related to software, hardware, and other equipment; and 4) creation of a customs liability for import of goods, and, in the absence of such liability, date on which such liability would otherwise have arisen. Therefore, for a VAT payer, in most cases the tax liability will arise at the time the invoice for goods or services is issued.

VAT relief rules in Serbia

For transactions involving goods and services, the taxable base is the consideration (in money, items, or services) that is or should be received by the taxpayer for the services or goods from the recipient of the services or goods or a third party, including subsidies and other income, not including VAT, unless otherwise provided for by the VAT Law (Art. 17 VAT Law). For goods transactions without consideration, the purchase price or cost price of those or similar goods at the time of the transaction is deemed to be the taxable base, whilst, for services, the cost price of the relevant or similar services at the time of the transaction is taken as the taxable base (Art. 18[1] and [2] VAT Law).

A VAT payer may claim VAT relief for debt not collected or collected only partially. Article 21[5] of the VAT Law allows VAT payers to claim relief for bad debt on the basis of:

1. final court ruling closing a bankruptcy proceeding, or

2. certified transcript of the court settlement order.

In all other cases, where the consideration for a transaction involving goods or services could not be collected in whole or in part for other reasons (lapsing of the receivable due to statute of limitations, suspension of enforced collection proceeding, and the like), the VAT payer may not claim VAT relief for non-performing receivables.^[9] As such the creditor, as the VAT payer, is required to pay VAT on transactions where the price remains uncollected even though legal action has been taken with the aim of ensuring collection.

The VAT Law stipulates exceedingly strict requirements for VAT relief if the VAT payer has failed to collect, or has only partially collected, a goods or services receivable. These rules have two consequences. Firstly, the creditor faces greater tax costs if unable to collect, since the VAT Law envisages only two circumstances in which VAT relief may be sought for bad debt. Secondly, the price at which the receivable can be sold will increase, because the creditor will include the VAT payable on the transaction underlying the receivable. For these reasons, the VAT payer creditor has a tax liability, and these costs may significantly affect the price of the receivable they may sell, and, as such, the profitability of that receivable for the assignee.

VAT relief rules in other jurisdictions

Countries in the region impose similar requirements, but these are nevertheless not as restrictive as in Serbia. Neighbouring countries that are EU Member States do not have such restrictions in place. For instance, in addition to the same requirements as set out in the Serbian VAT Law, Montenegro allows taxpayers to claim VAT relief they obtain a final court ruling suspending an enforcement proceeding or another document proving the taxpayer did not receive payment following a legal proceeding or did not receive payment in full due to the debtor being struck from the court register or a similar rolls.^[10] In Croatia, a taxpayer may claim VAT relief for non-performing where the taxpayer that received the goods or services claims input VAT relief and notifies the supplier thereof in writing, or, if the taxpayer is not a VAT payer in Croatia, such taxpayer notifies the supplier in writing that it has not applied for VAT refund.^[11] The United Kingdom also has fairly straightforward requirements for claiming VAT relief. For a VAT payer to be able to benefit from VAT relief, 1) the receivable must be over six months old; 2) the receivable must have been written off; 3) the claimant must maintain a record of receivables written off; 4) the claimant must have already accounted for and paid the VAT; and 5) the value of the goods or services concerned must not exceed their open market value.^[12] Each EU Member State sets its own requirements for claiming VAT relief for non-performing or partially performing debt. However, these countries are restricted in doing so; the European Court of Justice (ECJ) has ruled that the requirement to obtain a final court decision closing a bankruptcy proceeding was contrary to the VAT Directive.^[13]

In Denmark, the taxable amount (VAT exclusive) may be adjusted in bankruptcy proceedings, compulsory or voluntary composition, and execution levied by bailiff or sale by order of court. Danish authorities have of late allowed taxpayers to adjust output VAT on small bad debt losses if the creditor has made efforts to recover the debt proportional to the size of the debt. The creditor can consider the loss incurred if it is decided that further recovery is unprofitable after an individual assessment (Art. 27[6], Danish VAT Act).^[14]

Spanish VAT rules permit VAT relief subject to the following requirements: 1) one year must elapse from the time VAT became chargeable (smaller entities may opt to wait only 6 months); 2) the unpaid invoice must be registered in the provider’s VAT records; and 3) the customer must be a taxable person or the taxable base of the transaction must be greater than EUR 300. The creditor needs to have sought recovery by means of a judicial claim or through a notary public (if the debtor is a public body, a specific certificate must be obtained in which the pending debt is outlined) (Art. 80[4], Spanish VAT Law). Article 80[3] of the Spanish VAT Law also permits VAT recovery for bad debts when the debtor enters bankruptcy. In this case, some specific formal and timing requirements must be complied with (other than those set forth in Art. 80[4] VAT Law).^[15]

TAX TREATMENT OF THE SALE OF NON-PERFORMING RECEIVABLES

This part of the assessment looks at assignment of receivables by a contract by which the assignor assigns a receivable arising from a commercial transaction (provision of goods and/or services) to the assignee for consideration. The consideration represents the discounted amount of the nominal value of the receivable determined by mutual agreement of the parties.

Sale of receivables from the perspective of CIT

A creditor holding a non-performing receivable may assign (sell) that receivable to another person at a discount relative to its nominal value. By doing so, the creditor secures recovery of a portion of the receivable assigned, but the CIT Law also provides tax relief by recognising the difference between the nominal outstanding debt and the price at which the receivable was assigned as a tax expenditure.

The loss incurred by the assignor when selling the receivable is recognised as an expenditure in the tax balance sheet in the amount presented in the assignor’s profit and loss account for the tax period in which the receivable is assigned (Art. 16a[1] CIT Law). This allows the creditor to use the discounted amount at which the receivable was sold as an expenditure in its tax balance to reduce its taxable base for the tax period in which the sale took place. Where the assignor has impaired the receivable, the impairment loss recognised as expenditure will remain recognised without the assignor having to meet the requirements of either Article 16[1]3) (which requires the assignor to have taken sufficient legal action in an attempt to recover the claim) or Article 16[2] of the CIT Law.

Assignment of a non-performing receivable has multiple benefits for the assignor over write-off. The first advantage is that the assignor may claim the loss incurred when selling the receivable as a tax expenditure, thereby using the discounted value of the receivable to reduce its CIT taxable base. Secondly, the assignor need not pay the costs of legal actions in recovery of the receivable it would otherwise have to take to ensure the receivable is permanently recognised as an expenditure.

The assignee, as the new creditor, is also entitled to impair the receivable acquired under an assignment contract. The impairment loss recorded by the assignee in its books of account is recognised in the tax balance sheet submitted for the tax period in which the impairment is made, provided that the receivable is at least 60 days past due at the end of the tax period.^[16]

The assignee accounts for a purchased receivable at its depreciated value, which is the purchase price inclusive of transaction costs (the amount at which the receivable is initially recognised) less any payment of principal (if payment is made in instalments) and less any impairment.^[17]

Sale of receivables from the perspective of VAT

Assignment of receivables for consideration is exempt from VAT without allowing the taxpayer to deduct input VAT. Pursuant to Article 25[1]6) of the VAT Law, VAT is not paid on cash and capital transactions in connection with operations and intermediation involving monetary claims, cheques, bills of exchange, and other similar securities, excepting collection of receivables on behalf of another party. As such, when a VAT payer assigns a monetary claim to an assignee, the VAT is not assessed or paid, whilst the assignor is not entitled to deduct input VAT.^[18]

The same treatment applies to factoring transactions. The VAT Law allows tax exemption without deduction of input VAT for cash and capital transactions, including operations and intermediation involving monetary claims, except collection on behalf of another party. As such, VAT is not assessed or paid on factoring fees, whilst the VAT payer providing the factoring service (the factor) is not entitled to deduct input VAT. As the factor collects matured receivables in its own name and on its own behalf (rather than collects receivables on behalf of another party), this is a service exempt from VAT without deduction of input VAT under the VAT Law.^[19]

TAX TREATMENT OF NON-PERFORMING RECEIVABLES AND THEIR SALE – KEY FINDINGS

[1] Regulation on recognition, valuation, presentation, and disclosure of positions in individual financial statements of micro and other legal entities (Official Gazette of the Republic of Serbia, No. 89/2020), referred to as ‘Regulation on micro and other legal entities’ throughout.

[2] Article 16[2] of the CIT Law sets out requirements for recognition of write-off of receivables that are not accounted for as income pursuant to accounting regulations and IAS, or IFRS and IFRS for SMEs, whilst Article 16[3] and [4] provide for exemptions to some of the three requirements in the event of financial restructuring and write-off of receivables covered by pre-packaged reorganisation plans.

[3] Including fees and other public revenues payable under the Court Fees Law.

[4] Opinion of the Ministry of Finance No. 430-00-512/2019-04 of 10/2/2020.

[5] Article 9[1]-[3] of the Croatian Corporate Income Tax Law (Zakon o porezu na dobit) (Narodne novine, br. 177/04, 90/05, 57/06, 146/08, 80/10, 22/12, 148/13, 143/14, 50/16, 115/16, 106/18, 121/19, and 32/20), in force and effect as of 20 March 2020, excepting Art. 30h, due to take effect on 1 January 2022.

[6] Article 17[1] of the Montenegrin Corporate Income Tax Law (Zakon o porezu na dobit pravnih lica) (Službeni list Republike Crne Gore, Nos. 065/01 of 31/12/2001, 012/02 of 15/03/2002, and 080/04 of 29/12/2004; Službeni list Crne Gore, Nos. 040/08 of 27/06/2008, 086/09 of 25/12/2009, 040/11 of 08/08/2011, 014/12 of 07/03/2012, 061/13 of 30/12/2013, and 055/16 of 17/08/2016).

[7] Article 17[1] of the Federation of Bosnia-Herzegovina Corporate Income Tax Law (Zakon o porezu na dobit) (Službene novine FBiH, Nos. 15/2016 and 15/2020).

[8] Article 21[1] of the Republika Srpska Corporate Income Tax Law (Zakon o porezu na dobit) (Sl. glasnik Republike Srpske, Nos. 94/2015, 1/2017, and 58/2019).

[9] Mišljenja Ministarstva finansija, br. 401-00-02666/2013-04 od 10.4.2014. godine, odnosno br. 413-00-00927/2011-04 od 20.10.2011. godine).

[10] Article 20a[2] of the Montenegrin Value Added Tax Law (Zakon o porezu na dodatu vrijednost) (Sl. list RCG, Nos. 65/2001, 12/2002 – ispr., 38/2002, 72/2002, 21/2003, 76/2005, 4/2006 – ispr. and Sl. list CG, Nos. 16/2007, 40/2011- dr. zakon, 29/2013, 9/2015, 53/2016, 1/2017, 50/2017, 46/2019 – dr. zakon, and 80/2020).

[11] Article 33[7] of the Croatian Value Added Tax Law (Zakon o porezu na dodanu vrijednost) (Narodne novine 73/13, 99/13, 148/13, 153/13, 143/14, 115/16, 106/18, and 121/19).

[12] HMRC Internal Manual, VAT Bad Debt Relief. Available at gov.uk/hmrc-internal-manuals/vat-bad-debt-relief/vbdr1500.

[13] The European Court of Justice (ECJ) has adopted several rulings on conditions for VAT relief. In a case concerning Italian regulations that make tax relief conditional on the existence of a final court ruling closing an insolvency proceeding, certainty that a debt was definitely non-collectable could in practice be gained only after some ten years. The ECJ took the view that such a period would disrupt the cashflow of any retailer subject to this legislation relative to their competitors in other Member States, which plainly went against the objective of fiscal alignment. In conclusion, the ECJ felt that the VAT Directive did not permit disproportionate restrictions on VAT adjustment in such cases. A similar ruling was adopted with regard to Greek legislation. See Ernst & Young, VAT on bad debts, ey.com/Publication/vwLUAssets/ey-transfer-pricing-alert-november-2017-eng/$FILE/ey-transfer-pricing-alert-november-2017-eng.pdf. International tax review, Greece: ECJ decision on bad debt VAT relief could serve as a guide in many Greek cases, internationaltaxreview.com/article/b1f7n2rz2mz42w/greece-ecj-decision-on-bad-debt-vat-relief-could-serve-as-a-guide-in-many-greek-cases. PWC, Tax Flash, VAT relief on bad debts – ECJ Decision in favour of taxpayers, pwc.com/gr/en/newsletters/tax-flash-vat-bad-debt-relief.pdf.

[14] European Commission, Rules applicable in EU Member States with relevance to supplies of telecommunications, broadcasting and electronic services to non-VAT taxable persons located in the EU and the application of the Mini One Stop Shop, 2018, available at ec.europa.eu/taxation_customs/sites/taxation/files/2018-01_01_moss_report.xlsm.

[15] Ibid.

[16] Opinion of the Ministry of Finance No. 430-00-512/2019-04 of 10/2/2020.

[17] Opinion of the Ministry of Finance No. 011-00-332/2017-16 of 26/5/2017.

[18] Opinion of the Ministry of Finance No. 430-00-529/2012-04 of 17/4/2012.

[19] Opinion of the Ministry of Finance No. 011-00-00648/2017-04 of 31/8/2017.