VAT bad debt relief and insurance

The CJEU has held that an insurer which indemnified bad debts, including a proportion of the VAT on those bad debts, was not entitled to recover input VAT on its payments: Euler Hermes (Case C-482/21). The Court held that payment by the insurer amounted to third-party consideration such that the debts were not unpaid to that extent and, in any event, the right to relief for bad debts was limited to the taxable person and could not be obtained by an insurer in the position of Euler.

Background

Euler was a Hungarian insurance company that entered into arrangements to compensate policyholders in the event of non-payment by their customers of debts. Where it insured a debt, the rights of the policyholders in relation to the debt were attributed to Euler. The amount paid was 90% of the unpaid debt, including VAT. As a result, Euler effectively bore the cost of 90% of the unpaid VAT in such cases. It should be noted that prior to 2020 Hungary did not permit any VAT bad debt relief (contrary to EU law).

In the circumstances, Euler applied for a refund of the VAT on the irrecoverable debts. That request was rejected by the Hungarian tax authority on the basis that Euler had not carried out the transactions on which the VAT had been incurred and so it was not Euler’s input VAT. The matter was referred to the CJEU.

Decision of the CJEU

Euler argued that since it was the successor in title to its policyholders in relation to the debts, it was entitled to a refund of the VAT relating to the irrecoverable debts. In addition, it argued that the principle of fiscal neutrality could be relied on, particularly in the light of the fact that Hungarian law did not allow for VAT bad debt relief.

The CJEU noted that Article 90 of the Principal VAT Directive, which provides for a reduction in the amount of VAT payable in cases of cancellation, termination, rescission, total or partial non-payment or price reduction embodies a fundamental principle, the principle of fiscal neutrality, according to which the taxable amount is the consideration actually received.

However, the Court also noted that for a transaction to be effected for consideration, it is not a factor that the consideration must be received directly from the recipient of the supply. The consideration may also be received from a third party. In the analysis of the Court, the payment of 90% of the debts by Euler to the suppliers amounted to part payment of the debts and, accordingly, its customers cannot be regarded as being subject to non-payment within the meaning of Article 90 of the PVD.

Secondly, the Court went on to indicate that, in any event, an insurer in the position of Euler cannot be identified as the taxable person entitled to a reduction of the taxable amount for the purposes of Article 90 to the extent that the debts remained unpaid.

Comment

Although the Court refers to the service in this case as insurance, the arrangements appear very similar to debt factoring. The VAT treatment of debt factoring is a complex area and specialist advice should be sought on any particular arrangements. However, it is clear that any input VAT on the supplies which gave rise to the original debts cannot become the input VAT of the factor or insurer by virtue of such arrangements.

In the UK, HMRC guidance in Notice 701/49 appears to be in line with this judgment in stating that, “A factor cannot claim bad debt relief for debts assigned to him by his client. The client cannot claim bad debt relief for a debt assigned to a factor but can do so if the factor re-assigns the debt to him”.

More broadly, the analysis of the CJEU that the payment of an amount by an insurer under such arrangements, in essence, amounts to payment of third party consideration appears novel. And it is far less clear that this is in line with the current UK position. For example, the VAT Bad Debt Relief Manual states (at VDBR2100) that, “If a business takes out an insurance or similar policy to pay out in the event of their customer’s debt going bad, this does not constitute a payment for the purposes of establishing whether it can claim bad debt relief.”

However, it does align the position with other payments by way of indemnification (for example of landlord costs). Again, careful analysis of the actual factual situation will be necessary to determine the VAT consequences.