Doubtful Accounts Receivable

We continue to address our clients' questions.

So, the question:

We want to write off to expenses a doubtful receivable from a private entrepreneur (FOP) for previously rendered paid services, for which the statute of limitations has not expired (we have a court decision for the compulsory collection of this debt in our favor, but court enforcement officers are unable to locate the counterparty). Our tax inspector informed us by phone that in case of such a write-off, we would need to increase the financial result by the amount of such debt for corporate income tax purposes in accordance with sub-paragraph 140.5.10 of the Tax Code of Ukraine (TCU) (reason – the existence of a letter from the SFS dated 23.07.2018 No. 3236/6 / 99-99-15-03-02-15 / IPK), and also perform the functions of a tax agent, paying personal income tax (PIT) to the budget from the amount of such write-off. Please help us understand how well-founded the tax inspector's position is.

Answer:

Sub-paragraph 140.5.10 of the TCU indeed requires an increase in the taxpayer's financial result «by the amount of transferred irrevocable financial assistance (goods, works, services provided free of charge) to persons who are not taxpayers (except for individuals)». That is, current legislation requires an increase in the financial result under this point only in the case of the transfer of irrevocable financial assistance or the free provision of goods (works, services) to non-corporate income taxpayers (and even these cases do not apply to individuals). Even if we assume that «private entrepreneur» and «individual» are not identical concepts for the purposes of applying this sub-paragraph of the TCU (although, in our opinion, this assertion can be successfully disputed), even in this case, we see no grounds for applying sub-paragraph 140.5.10 of the TCU.

The reasons for this are as follows:

1. The very fact of free transfer of any goods (works, services) by the taxpayer is absent – services to our FOP were previously provided by the taxpayer based on a corresponding commercial agreement, which stipulated their payment. Currently, we can only talk about a possible write-off in the taxpayer's accounting records of a doubtful receivable from one of its counterparties, which arose as a result of the taxpayer fulfilling its obligations under the relevant agreement for paid service provision. Thus, in this case, it is impossible to consider the services previously provided by the taxpayer to this FOP as «goods, works, services provided free of charge» (given their absolute non-compliance with the definition specified in sub-paragraph 14.1.13 of the TCU).
2. Also, in this situation, we cannot speak of «transferred irrevocable financial assistance». Even if we agree that this debt falls under the definition of «irrevocable financial assistance» as provided in sub-paragraph 14.1.257 of the TCU (although this would be more than debatable if the taxpayer manages to prove that the statute of limitations has not expired for this debt), in our situation, there is still no fact of monetary transfer (since we are dealing with a counterparty's receivable for services rendered to them).

As for the necessity for the taxpayer to perform the functions of a «tax agent» in this situation, in our opinion, it is entirely possible to apply the provisions of sub-paragraph d) of sub-paragraph 164.2.17 of the TCU, according to which the total taxable income of an individual includes:

«The principal amount of debt (loan) of the taxpayer, forgiven (annulled) by the creditor by its independent decision, not related to bankruptcy proceedings, before the expiration of the statute of limitations... The creditor is obliged to notify the taxpayer-debtor by sending a registered letter with acknowledgment of receipt or by signing a corresponding agreement, or by personally providing a notification to the debtor against signature about the forgiveness (annulment) of the debt and to include the amount of the forgiven (annulled) debt in the tax calculation of the income amount accrued (paid) in favor of taxpayers, based on the results of the reporting period in which such debt was forgiven. The debtor independently pays tax on such income and reflects it in the annual tax declaration. In case the creditor fails to notify the debtor of the forgiveness (annulment) of the debt in the manner specified in this sub-paragraph, such creditor is obliged to perform all duties of a tax agent regarding the income defined by this sub-paragraph».

Thus, upon fulfillment of the following conditions:

1. The taxpayer's decision (not related to bankruptcy proceedings, before the expiration of the statute of limitations) to forgive (annul) the principal amount of the individual's debt (such decision must be documented).
2. Notifying this individual by sending a registered letter with acknowledgment of receipt or by signing a corresponding agreement, or by personally providing a notification to the debtor against signature about the forgiveness (annulment) of the debt. The Ministry of Finance of Ukraine, in the General Tax Consultation approved by Order No. 400 dated 03.04.2018, confirmed that «sufficient confirmation of proper notification of the debtor in this case may be a corresponding document confirming the fact of submission of the relevant notification, including a settlement document (cash receipt, settlement receipt, etc.) issued by a postal service operator registered in the unified register of postal service operators, confirming the provision of postal services, and in case of sending grouped postal items – a settlement document and a copy of the list of items» (i.e., documentary confirmation of the individual's receipt of such documents is not required).
3. Inclusion of the amount of the forgiven (annulled) debt in the tax calculation of the income amount accrued (paid) in favor of taxpayers, based on the results of the reporting period in which such debt was forgiven, the taxpayer will have all grounds not to transfer PIT to the budget from the amount of the write-off of the doubtful receivable from the FOP.