The deductibility of impairment losses on trade receivables for Corporation Tax purposes and the modification of the tax base for VAT purposes

Loan defaults are a reality that many companies face in their day-to-day business activities. It is therefore important for taxpayers to be clear about their correct tax treatment in order to comply with their tax obligations in accordance with the regulations in force at any given time.

In this publication we address the tax treatment of loan defaults, analysing the deductibility in Corporate Income Tax (hereinafter, IS) of the losses that may arise from the impairment of these items, and the procedure for modifying the taxable base in Value Added Tax (hereinafter, VAT) and recovering unpaid tax charges.

Generation and impairment of trade receivables

When is a trade credit generated?

In general, each time a company delivers goods or provides a service, it issues an invoice to its client for that transaction. For accounting purposes, the company will record a revenue as well as a receivable, provided that payment has not been made in cash.

When is a trade credit impaired?

Impairment is an accounting expression used to refer to the valuation adjustment of an asset or liability whose actual value is estimated to have decreased and is therefore lower than the value initially recorded.

In practice, it is common to encounter situations where, after the due date of the invoice, the debt is not paid by the debtor and the company wonders whether it will be able to collect it.

In these cases, the General Chart of Accounts requires a reclassification of the balance of the client account and its identification as a doubtful balance. In parallel, a provision is made by recording an impairment loss on the receivable.

What are the tax effects of recording an impairment loss on trade receivables for corporate income tax purposes?

As mentioned above, the impairment of the value of the trade credit entails reflecting a loss in the company’s profit and loss account, the result of which is the starting point for calculating the taxable base for corporate income tax.

In this respect, it is of great importance to analyse whether the loss recognised meets the requirements established by the Corporate Income Tax Act for its deduction, or whether, on the contrary, a positive adjustment must be made.

When are impairment losses deductible for corporate income tax purposes?

Article 13.1 of the Corporate Income Tax Act provides that losses recognised for impairment of uncollectible receivables are deductible and may therefore be included in the tax base when, at the time of accrual, i.e. on the last day of the tax period, any of the following circumstances apply:

1. The period of 6 months has elapsed since the maturity of the obligation.
2. The debtor is declared bankrupt.
3. That the debtor is being prosecuted for the offence of embezzlement.
4. The obligations have been the subject of a legal claim or are the subject of legal proceedings or arbitration proceedings on the settlement of which their recovery depends.

Notwithstanding the foregoing, the aforementioned provision adds that in no case shall losses due to impairment of receivables be considered deductible when they correspond to:

• Claims owed by public-law bodies, unless they are the subject of arbitration or court proceedings concerning their existence or amount.
• Credits owed by related persons or entities, unless they are in insolvency proceedings and the liquidation phase has been opened by the judge, in accordance with the terms established in Law 22/2003 of 9 July 2003 on Insolvency Proceedings.
• Overall estimates of the risk of client and debtor insolvencies.

With regard to the latter case, it should be clarified that those entities that are considered small entities in accordance with the provisions of Article 101 of the Corporate Income Tax Act may deduct the impairment loss on loans to cover the risk arising from possible insolvencies up to a limit of 1 % of the debtors existing at the end of the tax period.

For these purposes, debtors on which impairment has already been recognised, or those that are not deductible by express provision of the regulations, shall not be taken into account in the calculation.

What are the VAT implications of loan defaults?

When a trade credit is generated, the value of the credit will generally consist of the price of the good delivered or service rendered, plus the corresponding value added tax charge, which the company has to pay to the tax authorities within the reporting period, regardless of whether or not the credit has been collected.

Is it possible to recover the paid VAT?

Article 80 of the VAT Law lists a number of cases in which the taxable amount of the tax may be changed.

In particular, mention should be made of those cases in which the recipient of the transactions subject to the tax has not paid the amounts charged and, in addition, any of the following situations apply:

• That the client is in insolvency proceedings. For this to be the case, the declaration of bankruptcy must be issued after the accrual of the transaction. In this case, the modification may not be made after a period of three months has elapsed from the day following publication in the Official State Gazette of the order declaring bankruptcy.
• Where claims are wholly or partially uncollectible.

When are receivables considered uncollectible for VAT purposes?

To this end, for a claim to be considered totally or partially uncollectible, it is necessary for it to meet a series of temporal and subjective requirements:

1º. 1 year has elapsed since the accrual of the output tax without all or part of the credit derived therefrom having been collected.

However, where the enterprise holding the credit is not a large enterprise for VAT purposes, the time limit may be 6 months or 1 year.

2º. That this circumstance be reflected in the Invoice Register Book.

3º. The recipient of the transaction must be a businessperson or professional. Otherwise, the VAT taxable amount must be more than 50 euros.

4º. That the company holding the claim has requested its collection by means of a judicial claim against the debtor or by means of a notarial summons to the debtor, or by any other means that reliably accredits the claim against the debtor, even in the case of claims secured by public entities.

Which credits are not liable to change the tax base?

– Claims secured by collateral, to the extent of the secured portion.

– Those guaranteed by credit institutions or mutual guarantee societies or covered by a credit insurance or surety insurance contract, in the part guaranteed or insured.

– Those between related persons or entities.

– Those owed or guaranteed by public bodies.

What actions are necessary to change the tax base?

• The taxable person must prove that he has sent the corresponding corrective invoice to the recipient.
• The transactions must have been invoiced and accounted for by the creditor in a timely manner.
• The modification must be notified to the tax authorities. This obligation to notify modifications to the tax base, both for the creditor and the debtor, must be done electronically, on a specific form available at the AEAT’s electronic headquarters.

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