Coordination Committee: correction of tax base for bad debts – knowledge test
The Coordination Committee of the General Financial Directorate and the Chamber of Tax Advisors of the Czech Republic has finalised its discussion paper concerning the ‘knowledge test’, i.e. whether a creditor knew, should, or could have known at the time of a delivery of goods or provision of services that the supply would not be properly paid, and its implication for correcting the VAT base for irrecoverable debts.
The paper mainly deals with determining the point in time of a delivery of goods or provision of services for various types of contracts where goods are let for use (i.e. operating leases) or contracts for work. Generally, the VAT stipulates when a creditor may correct the taxable amount of an irrecoverable debt, and when such correction cannot be made. In particular, this includes a situation where at the date of delivery of goods or provision of services at the latest the creditor knew, should, or could have known that the supply provided would not be properly paid – the ’knowledge test’.
In practice, determining the time of the delivery of goods does not cause such problems as does determining the time of the provision of services, in particular where partial supplies are involved, e.g. under a contract for work or an operating lease. The GFD agrees with the conclusions of the paper that the lessor (creditor) evaluates the customer's ability to pay at the time of concluding the contract, and individual partial supplies are then made automatically, as per the contract. If the lessor acts with due managerial care, i.e. monitors the customer’s payment discipline and takes the necessary steps (incl. early termination of the contract) in the event of default, then the knowledge test should not apply to them. Due managerial care shall mean in particular warning the lessee of the first and every subsequent unpaid instalment and then making one’s best effort to ensure that the first and every subsequent unpaid instalment do not remain unpaid.
Regarding an early termination of a contract, the submitters of the paper propose two possible approaches. Under the first approach, the compensation that the customer is obliged to pay upon early termination shall be regarded as an additional increase in the price of the original supply; the lessor would thus be obliged to correct the taxable amount, which is also in line with the current case law of the Court of Justice of the European Union (Vodafone Portugal C-43/19 case). This would in fact involve an increase in the price of all the partial supplies so far carried out. However, the GFD prefers the second proposed approach, under which the compensation shall be considered a separate partial supply effected on the date of the early termination of the contract.
To summarise the conclusions of the Coordination Committee: the knowledge test shall not apply to partial supplies that occur 'automatically' and for which the creditor, even if acting with due managerial care, has virtually no control over whether each partial supply will be paid. As for the compensation upon early contract termination, the GFD regards it as a separate supply effected at the time of the early termination.