In these turbulent times, issues with unpaid invoices or late payment may not only cause valuable time to be spent on accounts receivable management, but equally cause working capital levels to skyrocket.
In order to mitigate the financial impediment of no (or late) payment and to alleviate their financial departments from additional administration, taxpayers may increasingly rely on solutions that facilitate and/or advance the collection of accounts receivable. One of these solutions – that comes in all shapes and sizes – is factoring.
As credit institutions may be very selective in accepting new factoring agreements these days (especially for non-recourse and advance factoring), the below is rather to be read as a reminder of a few general principles with respect to factoring. For existing factoring agreements, it may also be worthwhile checking the contractual framework as some contracts may be terminated as a result of a material adverse change clause.
Item #9: Factoring as an answer to short term liquidity issues
As outlined above, there exists a wide variety of factoring solutions, each of them having their own tax specifics. Without being exhaustive, we summarised a few tax considerations below.
Recourse vs. non-recourse factoring.
In the event of recourse factoring, the taxpayer does not transfer the credit risk of the accounts receivable to the factor. Instead, upon default, the doubtful receivable returns to the taxpayer who may consider recording a write-down (or eventually a capital loss) on this receivable. In a recent circular letter on the exemption conditions for write-downs on trade receivables (click here), the Belgian tax authorities confirmed that the drastic measures taken by the government in the context of the spread of the Covid-19 virus are to be regarded as exceptional circumstances that occurred during the taxable period, justifying a write-down on trade receivables on entities having a backlog in payments following these specific measures. For non-recourse factoring arrangements, the credit risk is (mostly) shifted to the factor. However, in most instances the credit cover will be capped at a predetermined percentage, implying that some of the credit risk may return to the taxpayer.
Whilst maturity factoring – where the invoice is typically paid at collection or maturity – does not impact the group’s interest deduction under new interest barrier rules, advance factoring (or old line factoring) – where a portion of the invoice is paid prior to collection or the invoice reaching maturity – yet includes a financing component that is to be viewed as a cost equivalent to a borrowing cost for the 30% EBITDA calculation. Hence, when determining the excess borrowing cost under the 30% limitation, a portion of the total factoring fee (i.e. the interest component) may need to be included depending on the specifics of the factoring arrangement.
Another tax consideration in the context of advance factoring is the qualification and tax residency of the factor. Indeed, as a portion of the factoring fee is to be viewed as an interest component, a 30% WHT may apply on part of the factoring fee (unless a domestic or treaty exemption would apply). This is particularly relevant in the context of cross-border factoring.
Whereas we assumed so far that the factor is a third party, it may well be that the accounts receivable are centrally managed by a related party and are part of a captive factoring arrangement. In these instances, the tax deductibility and transfer pricing aspects of the factoring arrangement will obviously require careful attention and contemporaneous documentation.
Also the VAT treatment of factoring should be duly considered. Factoring – with or without recourse – is regarded as a debt collection service, which is typically subject to VAT. Hence, factoring is taxed at the normal VAT rate. In addition, factoring companies may grant advance payments to their customers. This is from a VAT point of view regarded as a financial/credit transaction clearly distinct from the factoring service and which is exempt from VAT.
It is clear from the above that, although factoring is a common financial instrument, the tax consequences related thereto should be examined on a case-by-case basis.
While most companies have applied for the COVID-19 measures available by now, we see that quite some groups struggle to monitor closely their short-term (and certainly mid-term) cash position and how to manage and optimise it further to steer their company through this crisis in the best way possible. We meanwhile have created the following email platform: firstname.lastname@example.org in order to give you a sounding board in these challenging times.