VAT reduction possible on bad debts from 2022

Jaana Sild
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From 1 January 2022, the Estonian Value-added Tax Act will have a new section, 291, setting forth the conditions based on which taxable persons can reduce their tax liability on bad debts. This is a long-awaited addition to Estonian tax law that has previously been discussed but has not gone beyond the draft legislation stage.

Previously VAT liable persons were not entitled to adjust declared output VAT to exclude invoices that are partly or completely unpaid and which are doubtful to be received in future. Since VAT is often due before customers pay invoices, VAT on such bad debts may accumulate over time.

On what grounds can the tax obligation be reduced?

The basis for the adjustment to declared output VAT is a bad debt that has been written off in accounting. Before the receivable is written off, the taxable person has to make due efforts to collect on the invoice. If it turned out that in spite of the attempts, it is not possible (perhaps the debtor has already ceased to exist as a legal entity) or the collection costs exceed the amount to be collected, the receivable can be written off and the VAT obligation can be adjusted.

The legislation applies to receivables written off due to the buyer’s insolvency – a situation where the buyer has filed a complaint about the quality of the product or service and refuses payment cannot be used under this amendment as a basis for a write-off.

The amendment allows for a tax obligation adjustment only for receivables written off from 1 January 2022 on. VAT cannot be refunded on receivables that meet all the other conditions but were written off before the start of2022.

Conditions for the adjustment

To reduce their VAT obligation, the taxable person must meet all of the conditions set forth in subsection 291 (1).

  • Tax liability can be reduced only on receivables in conformity with the VAT Act. It means that an invoice compliant with the VAT legislation must have been issued for the goods or services and declared on the VAT return within taxation period the supply took place.
  • The taxable person and the purchaser of the goods or services are not related parties.
  • The receivable may not have been sold off. An alienated receivable is not a debt, as in essence it has been discharged by a third party.
  • More than 12 months but no more than 3 years has passed since the invoice due date. The Tax and Customs Board says such a shorter period is not sufficient to determine whether it is a bad debt and it would lead to abuse of the law.

Receivables exceeding 30,000 euros

Receivables greater than 30,000 euros (including VAT) are governed by special provisions. First of all, the aforementioned 12-month restriction on payment of the invoice does not apply to such receivables. Secondly, a court decision must be the basis for classifying receivables above this threshold as bad debts. Court decisions in this case is any enforcement document that proves the existence of the claim and that it is a bad debt (such as a payment order, decision on deletion from a registry, court order on abatement of a bankruptcy proceeding).

Notification requirement

The taxable person must notify the debtor in writing that the receivable has been written off (having first made all efforts to collect the debt). Only then can the taxable person adjust the VAT.

A debtor who receives such a notification and has first deducted input VAT on the basis of the unpaid invoice is obliged to adjust  input VAT within the taxation period in which they received the notice.

Thus, the amendment imposes a general obligation on taxable persons to keep an account of unpaid invoices and bad debts for both submitters of invoices and debtors.

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