New VAT Ruling of the Districts Court – Recognizing that Credit Notices may be Issued for “Bad Debt”
13 February 2022
New VAT Ruling of the Districts Court – Recognizing that Credit Notices may be Issued for “Bad Debt” Even if Seller Receives Proceeds of Credit Risk Insurance
Dear Clients, Colleagues and Friends,
Israel’s District Court has rejected the Tax Authority’s position and ruled that proceeds of credit risk insurance received in respect of the unpaid price for goods are not considered consideration in the sale transaction and the seller can issue “VAT credit notices”
The Central District Court – Lod recently heard joint appeals dealing with a common legal question which were filed against the Israel Tax Authority on behalf of Tnuva and others.
The legal question is whether the income Tnuva received from its credit risk insurance policy as a result of the buyer not paying for the goods negates its entitlement to issue VAT credit notices and receive a tax refund.
Tnuva purchased an insurance policy that gives it the right to receive compensation in cases where no consideration is recived for goods sold. As part of its business, Tnuva sold products to the ‘Mega’ chain and due to the chain’s insolvency, Tnuva did not receive the consideration. Therefore, Tnuva claimed under its insurance and received payment of approximately 85% of the total debt from its insurance company. In parallel, Tnuva issued three VAT credit notices totaling approximately 45% of the debt amount (the balance of the debt was covered out of the insolvency payments) and demanded a refund of the transaction tax. The Tax Authority issued a VAT transaction assessment to Tnuva, claiming that the VAT credit notices were issued illegally, since the debt was covered by Tnuva’s insurance policy and therefore it is no longer a bad debt.
The Honorable Justice Shmuel Bornstein rejected the claims of the Tax Authority and accepted the appeal, for the following reasons:
1. A distinction should be made between the relationship between the seller and the buyer on the one hand and the seller’s separate and external relationship with the insurance company on the other. The “bad debt” arrangement focuses only on the relationship between the seller and the buyer, and whether or not the transaction was actually completed with the transfer of the payment to the seller. Thus if the debt is not paid and is not expected to be paid by the buyer, then it is a bad debt.
2. The court distinguished between payments received from the buyer’s insurance company or guarantor – which should be considered as the payment for the products and therefore should not be considered a bad debt – and payments received from the seller’s insurance company that are external to the transaction and do not negate the status of the debt as a “bad debt”. This interpretation was given by the court to the Tax Authority’s own interpretation rules regarding bad debts, and in this regard further stated that, in any case, the Tax Authority’s interpretation rules are merely their internal professional guidelines, which do not bind the court in interpreting the provisions of the law.
3.Regarding the Tax Authority’s claim that accepting the appellants’ position will result in double compensation – the court rejected this claim since the appellant bore the premium payments to the insurance company, which is an external and separate agreement.
The court further added that according to the provisions of the policy and the law, the amount received from the VAT authorities will be refunded in full to the insurance company and thus address the concern of Tnuva receiving “double compensation”. The court also noted that in these circumstances, it may even be appropriate to allow Tnuva to issue the VAT credit notices and to receive a refund of its transaction tax, even assuming that the insurance policy would not obligate Tnuva to return the VAT amount to the insurance company.
4. In addition, the court also noted that, with respect to the ITA’s obligation had its position been accepted, to reduce the debt claim filed on its behalf in the Mega insolvency proceedings, that Mega should not be allowed to be unjustly enriched at the expense of the insurance company by allowing Mega to retain the input tax it deducted. The court found no reason to prefer all the creditors (the buyer’s liquidation asset pool), over the one creditor (Tnuva) with whom the transaction was made for which the VAT was not paid.
The judgment raises issues that must be examined in relation to the specific circumstances of the relevant case. We have extensive tax expertise, including in connection with refund of VAT and bad debts. We would be pleased to assist with any queries you may have.
Herzog Fox & Neeman