Recovery of unpaid debts

Effects on VAT

Unpaid. When an invoice remains unpaid, the creditor company can recover the VAT charged. To do this, it must wait a period from the date on which the transaction was accrued and, in the six months following the end of that period, issue a corrective invoice for the non-payment, calculating a lower VAT charged (and therefore recovering the VAT previously paid and still outstanding).

For these purposes, two "windows" are opened to make the correction: at six months and at one year. In the case of companies whose turnover in the previous year exceeded 6, 010, 121. 04 euros, only one "window" is opened, and the waiting period to carry out the VAT recovery procedures is always one year.

Additionally, it is necessary for the company to meet certain additional requirements. Among others:

• Having requested payment through a judicial claim, notarial requirement, or any other means that proves the claim (for example, a burofax).

• Within the month following the issuance of the corrective invoice, it must communicate this modification to the Tax Office through the electronic headquarters.

Recovery (debtor company). If the subsequent collection occurs and the client is another company (whether individual or an entity), the creditor does not need to do anything:

• Upon receiving the correction of the original invoice, the delinquent client had to include in their periodic declaration the VAT that had not been paid as a lower deductible VAT.

• As a result, the client became a debtor to the Tax Office for that amount (in fact, returned to the Tax Office the VAT that had been deducted and not paid, by including it as lower deductible VAT in their settlement ). Therefore, only the principal amount of the transaction remained outstanding without VAT.

However, the upward correction must be made when abandoning the judicial claim or reaching a collection agreement after the payment request has been made. In practice, therefore:

• The debtor pays voluntarily. The taxable base is not corrected again.

• The debtor pays after the judgment. Nor is the upward adjustment made.

• The creditor withdraws the lawsuit (spontaneously, not because the debt has been collected). In this case, the taxable base must be adjusted again (upwards).

• Debtor and creditor agree on a new due date. In this case, the taxable base must also be adjusted upwards.

Many times, the courts that resolve these litigations condemn the payment of the principal plus VAT –without taking into account that this VAT was no longer claimable, having been adjusted–. In that case, it is advisable for the creditor company to only collect the principal and waive the collection of said VAT. And if it is collected, then it will be obliged to adjust the taxable base upwards, since otherwise, it would be appropriating a sum that must be paid to the Tax Office.

Recovery (private client or Public Administration). In the event that the client acts as a private individual or public administration (that is, does not carry out a business activity), things change. Since the debtor does not have to file VAT returns, when the creditor company corrects the initial invoice and recovers the VAT, the debtor will not become indebted to the Tax Office. Therefore:

• If the client pays later, the creditor company must issue a new invoice with VAT, for the amount paid by the client.

• In these cases, it is understood that the VAT is included in the amounts received and in the same proportion as the part of the consideration received. For example, if the initial debt is 12, 100 euros (10, 000 euros plus 21% VAT) and a partial payment of 5, 000 euros is made, it will be considered that 4, 132 euros correspond to the principal and 868 euros to the VAT, an amount that the creditor company must break down in the new invoice and include in its periodic declaration as VAT collected.

Effects on Corporate Income Tax

Unpaid. Regarding Corporate Income Tax, for the creditor company, the unpaid debt will imply the recording of an expense for impairment of receivables. This expense will only be tax deductible if any of the following requirements are met:

• That the debtor has been declared bankrupt or has been prosecuted for fraudulent conveyance.

• That the company has initiated a judicial or arbitration claim against the debtor.

• Or that at least six months have passed since the due date of the transaction.

If at the end of the year the six months have not elapsed, the creditor company must account for a positive adjustment in Corporate Income Tax that cancels out the accounting expense, and wait until the following year to deduct the impairment (if it has not been collected by the new closing date).

In any case, the impairment will not be deductible:

• If the debtor is a public entity, unless an arbitral or judicial procedure has been initiated regarding the existence or amount of the debt.

• If the debtor is a company related to the creditor, unless it is in bankruptcy and the liquidation phase has been opened.

• If the debt has real collateral or is guaranteed by a solvent entity (a bank or a credit or surety insurance), no impairment should be recognized.

• If the company still recognizes it, it will not be tax deductible (for not complying with accounting regulations), except for the portion of the debt that has not been guaranteed (sometimes, these guarantees only cover part of the debt).

Recovery. If the creditor company subsequently collects and recognizes income (due to the reversal of the impairment expense previously recognized), it must verify whether that expense was tax deductible or not. If it was not – and therefore, it was subject to a positive non-accounting adjustment –, now it will have to make a counter-sign non-accounting adjustment, in order to fiscally neutralize the income and achieve fiscal neutrality of the transaction.

It may also happen that the debt is disputed by the debtor and the debtor obtains a favorable ruling (so that it is considered that there is no debt, or that it is lower than the amount claimed). In that case:

• If the impairment was already considered tax deductible, the creditor should not do anything: at the time of the ruling, it should cancel the accounts receivable and the impairment, with a neutral accounting and tax effect.

• If at the time the ruling is issued the impairment has not yet been considered tax deductible (because, for example, at the end of the previous fiscal year, six months had not yet elapsed since the maturity of the transaction), it will be sufficient for the creditor company to recognize a negative non-accounting adjustment in that fiscal year (in which the ruling is issued).

When the client is another company, the recovery will not imply a new upward modification of the taxable base. However, if it is an individual, this new adjustment must be made.