Possibility of reducing the VAT base of bad debts

VGD Hungary has launched a series of newsletters on the most important tax changes in 2020. In our current newsletter, we would like to draw your kind attention to the opportunity of reducing VAT base of bad debts and its rules.

According to the wording of the Hungarian Value Added Tax (“VAT”) Act, in force since 1 January 2020, taxpayers can subsequently (in the frame of self-revising) reduce their VAT base in a three-step process with the wholly or partly amount of the consideration recognized as bad debt. By doing so, Hungary has introduced into its national law this legal institution, which is already widespread in the Community. However, since the definition of bad debt is a Member State competence, the Hungarian legislation is stricter than in most Member States of the Community.

In the following we will briefly introduce the key details of the regulation.

Step 1: Examination of the bad debt nature of the claim in question

The opportunity of deduction can be exercised only in connection with bad debts according to the Hungarian VAT Act, therefore, it is very important that the definition in the Accounting Act should not be taken as a starting point.

Regarding the statutory VAT requirements, we consider important to highlight the followings:

• the claim must be a transaction performed by the taxpayer, who would like reduce its VAT base;
• the claim must come from the taxpayer’s such supply of goods or services grant which is in accordance with the VAT Act;
• the taxpayer has to record the amount in question as a bad debt in its VAT record;
• the possibility of deduction does not apply to transactions which are subject to reverse charge;
• the claim must be existing at the taxpayer (e.g. in the case of transactions affected by factoring or when the claim has been sold, the possibility of deduction cannot be exercised).

The taxpayers also should be able to prove that the claim has not been finally recovered and the following documents can help evidencing this (depending on the procedure):

• a negative booking report,
• a settlement agreement approved by a court order,
• a certificate or statement from the liquidator, and
• documents, related to the closure of the proceeding and the division of assets.

Step 2: Checking for other VAT statutory requirements

Once it has been determined that a claim is indeed eligible for the bad debt concept of the VAT Act, it is necessary to further investigate whether the taxpayer, who would like to reduce its VAT base, fulfils all other conditions relating to the application of the tax reduction.

Such non-exhaustive conditions are as follows:

• the seller (or service provider) and the buyer (or service recipient) must be independent of each other at the time of the transaction in question is carried out (i.e. they cannot be related parties and no employment relationship can be between them);
• the non-paying partner must be a taxable person at the time of the transaction and since then;
• the non-paying partner could not have been subject to bankruptcy, liquidation or compulsory liquidation at the time of the transaction, nor had his tax number been cancelled;
• at least one year must have passed since the payment was due (i.e. not since the date of performance);
• the non-paying partner must be notified in advance in writing;
• should be within the limitation period, etc.

All the conditions must be met in order to be eligible for the VAT base reduction, and of course the basic principles of taxation, such as so e.g. abatement must not be abusive, should be also applied.

Step 3: Calculating the VAT base reduction and completing the VAT return

If a claim not only meets the requirements of the VAT Act on bad debts, but the owner of the claim also meets the other conditions, then the VAT base can be reduced.

As mentioned in the introduction, reduction is possible only through self-revision and cannot be settled in the current VAT return. Although self-revision entails a declaration, there is no need to correct or invalidate the invoices concerned, since the taxpayer, who would like to reduce its VAT base has performed its duties in the transaction in question and the claim still exists. As a result, it is possible, that the non-paying partner later (after the VAT base reduction) settle its debt or at least a part of it. In this case, the VAT base should be increased with the value of debt settlements in the framework of (another) self-revision.

The self-revision statement can be made on page 6 of Form 65, as early as Form 1665, as the option to reduce can be applied for any transactions that complies with the conditions of the VAT Act and performed after 31 December 2015.

As it can be seen, the possibility of reducing the VAT base is not automatic, and its usage requires great care: there are many pitfalls in the three-step process, which can jeopardize the success of the procedure, moreover, the wrongful taxpayers can be sanctioned.

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Should you have any questions concerning this newsletter or should you are uncertain whether you are eligible for a VAT base reduction in connection with one of your long time non-paying customers, VGD Hungary’s tax advisory team is at your disposal.