Debtor’s insolvency: can you claim VAT bad debt relief?

Daniel WIĘCKOWSKI
Tax Director at RSM Poland

In Q1 2019, the number of insolvency and restructuring proceedings increased from 213 to 224 as compared with the same period last year[1]. Among industries with the highest risk of insolvency, the highest increase in the number of proceedings was recorded in wholesale trade (as much as 41%).

If insolvency or restructuring proceedings were commenced, this means that the chances of the creditor, i.e. the invoice issuer, to recover the funds due to them are dropping dramatically. Unfortunately, any sale of goods or services involves an obligation to account for the income tax and value added tax on this transaction, and regardless of whether the debtor has paid their liabilities in due time or not.

From the perspective of calculating corporate and personal income tax, if insolvency or restructuring proceedings were started, the creditor can write down the value of the receivables, thus increasing tax deductible costs. As a result, taxable income is reduced with a relevant cost write-down.

Unfortunately, even though the insolvency or restructuring proceedings of the debtor allows you to neutralise the negative implications of payment delays for income taxes, the same cannot be done at all when it comes to VAT.

According to the Polish regulations, a VAT taxpayer may reduce his output tax in the case in which the liability under the invoice they issued has not been paid or sold within 90 days from the date on which the debt became due and payable (this is known as bad debt relief). However, the creditor may claim this relief provided that there is no pending insolvency or restructuring proceedings towards the debtor on the day preceding the date of filing the tax return in which the output tax is reduced.

What does this mean for creditors of 224 companies in which either insolvency or restructuring proceedings were started in the first quarter this year? Through write-downs, they can partly compensate for the economic burden of the income tax. However, even though they did not receive any payment under invoices they had issued, they will have to pay VAT to the tax office out of their own pocket.

Is this a plausible solution? Under the Polish legislation, and most of all under Directive 122, the principle of VAT neutrality is present. Neutrality is understood here not only as the right to deduct the tax that was paid at the earlier stage of turnover, but also as a ban on making the tax an economic burden for the taxpayer. Based on the analysis of rulings of the Court of Justice of the European Union, a direct conclusion can be drawn that the taxpayer cannot be under obligation to pay the tax “out of their own pocket”.

On 6 December 2018, the Supreme Administrative Court submitted a prejudicial question to the Court of Justice, asking if under the EU law there are any restrictions to making a claim for bad debt relief, provided that the debtor is not going through insolvency proceedings. If the Court of Justice sustains its position, taxpayers who have been so far refused the right to claim bad debt relief will now be entitled to claim their money back.