Most suppliers account for VAT at the time the invoice is issued, i.e. before they are paid. But if a supply on which VAT is due and on which VAT has been declared goes wholly or partially unpaid, the EU VAT Directive says that the taxable amount (the amount on which VAT is declared) should be reduced.
This means the VAT that has been declared on it can also be adjusted. Individual EU Member States may determine the relevant conditions, and they may also derogate completely from that rule. So in essence, an EU Member State does not have to allow Bad Debt Relief (BDR), and if it does allow it, it can set the conditions of any BDR claim.
On the face of it, this seems to give an EU Member State the freedom to do as it likes when it comes to BDR. However, this is not the case, as the discretion allowed to an EU Member State to curtail a taxpayer’s EU rights by derogation is restricted by the requirement to adhere to certain fundamental principles.
One of these is that a relief should not be excessively difficult to secure. Another principle is that of equal treatment. So once an EU Member State decides to allow BDR, it cannot, for instance, limit it to supplies where the unpaid consideration is monetary rather than ‘in kind' – a Court of Justice of European Union (CJEU) decision which sheds some useful light on the scope of that BDR derogation.
Landmark decision in Upper Tribunal
In August of 2012 the UK Upper Tribunal also concluded that certain other BDR conditions which the UK previously imposed were also outside EU law. These conditions were known as the Insolvency Condition and the Retention of Title Condition. Essentially, from 1978 to 1997 the UK refused BDR for unpaid supplies of goods, where title did not pass until full payment was made.
From 1978 to 1990, it also refused BDR unless the customer was formally insolvent and, for part of that period, that the supplier had also proved in the insolvency, by submitting his claim in writing to the liquidator. The Upper Tribunal decided that it was not proportionate to apply one rule for supplies where title passed and another where it did not. A debt can still be a bad debt in either case, as it may not be possible for the supplier to secure the return of his goods.
Additionally, while it might be reasonable to require proof in insolvency before allowing BDR to be claimed for a large debt, the UK rules imposed the insolvency condition on all supplies, whatever their size. UK law also states that a supplier cannot even seek to make its customer insolvent unless the debts owed by the customer are over a certain minimum size.
The UK approach to BDR at that stage effectively made the relief impossible to claim in some cases, and difficult and expensive in others. These conditions were not proportionate and they were discriminatory. They went beyond the discretion envisaged by the Directive.
Although both GMAC and BT are open cases, the conclusions on the UK’s old BDR conditions are acte clair. That is, the Upper Tribunal is content that Community law is sufficiently clear on this issue that a reference to the ECJ is not needed.
Implications for other EU Member States
So the question is – which EU Member States allow BDR? If it does, what conditions does it attach to the relief? It is reasonable to make a supplier wait awhile before the debt can be considered bad, (the time limit in the UK is six months), because any non-payment may be temporary, meaning the debt is not bad.
It is also reasonable to require certain records of the bad debts to be kept, and to make a customer repay any input tax credit it has taken for the supply they have not and will not pay for. However, conditions that are discriminatory, disproportionate or make the relief excessively difficult to secure will not find favor. If applying the process adopted by the UK Upper Tribunal to the BDR rules in an EU Member State where you are based, do the BDR conditions seem disproportionate, discriminatory, or overly onerous?
Of course, another EU Member State may not be bound by a UK Tribunal decision, even one that sets a precedent in the UK. But they are bound by the EU principles the Upper Tribunal has explored and analyzed. Therefore, the cases of GMAC and BT could well have wider implications than just for UK supplies made years ago, before the UK’s BDR rules became less onerous.
The principles examined in GMAC and BT apply to supplies made in EU Member States, today, and could mean that taxpayers have the right to claim BDR on supplies they previously thought would have to remain unrelieved because of the terms of local VAT law.
Remember that a bad debt is one which has become payable and remains unpaid and which the debtors either cannot pay (because they have no means to do so) or which they simply refuses to pay in circumstances where it is in commercial terms not reasonable for the creditor to enforce. Where the parties simply agree to adjust the consideration downwards, the proportion of the original price that goes unpaid is not a bad debt as it is not a debt at all.