Waiver of Part of Debt to Creditor Reduces Corporate Income Tax

The Financial Operations and Pre-Bankruptcy Settlement Act, effective from October 1, 2012, regulates the deadlines for fulfilling monetary obligations between entrepreneurs and the consequences of delays in their fulfillment, as well as the procedure for pre-bankruptcy settlement over a company or the assets of a craftsman who has become illiquid or insolvent.

It introduces new institutes, and for some that have been applied until now, it introduces different tax rules.

One-Time Fee One of the novelties is the fee for late payment to which the creditor is entitled in a flat amount of 300 kuna for each monetary obligation. The debtor who delays the fulfillment of the monetary obligation is obliged to pay the creditor a one-time fee of 300 kuna, even if the creditor does not call for it. The one-time fee does not exclude or diminish the creditor’s right to default interest or any potential compensation for damages due to the debtor’s delay.
The newly introduced one-time fee is not subject to VAT. Namely, value-added tax is levied on the supply of goods and services for a fee, and in this case, there are no performed supplies, only the payment of a fee in a flat amount. If the creditor issues an invoice for this fee, the invoice should state the article of the regulation from which it follows that there is no obligation to charge VAT according to the relevant invoice. Specifically, it should refer to Article 25 of the Value Added Tax Regulation, just as in the case when an invoice is issued for default interest or compensation for damages due to contract termination.
The late payment fee is a tax-deductible expense for the debtor that will reduce the tax base for corporate income tax, while for the creditor, it is a financial income that increases their business result. In short, the newly introduced one-time fee has the same effect in tax terms as default interest or compensation for damages.

VAT and Input Tax The law introduces an obligation for the entrepreneur who has become illiquid and the entrepreneur who has become insolvent to initiate the pre-bankruptcy settlement procedure themselves. The essence of the pre-bankruptcy settlement procedure boils down to two things: the debtor must make plans for the financial and operational restructuring of their business, and in the procedure that proceeds according to strict rules, creditors negotiate with the debtor and ease their financial position by concessions. One form of the creditor’s concession is the waiver of part of the claim and the extension of payment deadlines for debts for which the settlement procedure has been opened.
The creditor’s waiver of part of the claim does not automatically mean a reduction of the VAT obligation that the creditor has already paid on the supply made to the debtor.
The creditor claims from the debtor the amount that includes the charged VAT, with the understanding that the VAT has already become due for payment based on the performed supplies or issued invoices. Of course, the debtor has realized the right to input tax based on this. A subsequent reduction of the creditor’s claim is actually a reduction of the fee for the performed supplies, therefore the creditor has the right to reduce the VAT obligation only if the debtor notifies them in writing that they have corrected their right to input tax in the same amount. This procedure can be the subject of a settlement and is carried out by correcting issued invoices. Of course, if the debtor agrees to correct the right to input tax, their position in relation to the Tax Administration worsens because their right to input tax decreases and their obligation to it increases.

Consequences of the Agreement The reduction of the debtor’s obligation in regular procedures in the debtor’s accounting increases revenues. This is not the case in the pre-bankruptcy procedure. According to the explicit provision of the law, the consequence of the reduction of part of the creditor’s claims achieved in the pre-bankruptcy settlement procedure is a reduction of obligations in the debtor’s business books, but the debtor does not record this reduction as income. The voluntary waiver of the creditor will not increase the income from operations for the amounts that the creditors have waived and will not affect the tax base for corporate income tax.
However, for the creditor, the tax effect is different. The waiver of part of the claim for which they have reached a settlement in the pre-bankruptcy procedure is a tax-deductible expense of the business that reduces their tax base for corporate income tax, but it also reduces the business result in the year in which the settlement was concluded. In this case, the creditor will not further reduce the tax base for corporate income tax if they have previously reduced it in the process of value adjustment of receivables from customers.
By writing off part of the receivables from their business books, creditors will feel the effects of the pre-bankruptcy settlement in the reduction of their business result. Until the waiver of part of the receivables, they recorded the total receivable as uncollected income, and after waiving part of the receivables, by recording the expense, they reduce their profit. Thus, the poor business of the debtor with whom they have dealt will directly affect not only their liquidity but also their business result.

dr. sc. Marija Zuber,
advisor-editor, Accounting and Finance magazine,  [email protected]