Could a Texas collection agency buy delinquent accounts and collect them as its own accounts without providing a taxable debt-collection service?

Plain-English summary

The Comptroller said it was not unlawful for a collection agency to actually buy a merchant's accounts receivable and then collect accounts it owned. But the economic substance of the agreement mattered.

If the merchant had to buy back uncollectible accounts, the Comptroller would not treat the arrangement as a true purchase. It would instead assess sales tax on the activity as a debt-collection service.

The letter also said the merchant was treated as paid when it sold or factored the account. A merchant that had paid tax would not receive a bad-debt deduction; a merchant that had not paid the tax would owe it on the original selling price of the taxable item.

The Comptroller would not give a definitive ruling without reviewing a representative purchase agreement.

What this means for you

The historical distinction was between a genuine sale of receivables and an arrangement that left collection risk with the merchant. A label such as “purchase” or “factoring” was not enough where the contract required the merchant to repurchase bad accounts.

Common questions

Was buying delinquent accounts prohibited? No. The letter said a collection agency could actually buy receivables and collect its own accounts.

What contract term would cause taxable debt-collection treatment? A requirement that the merchant buy back uncollectible accounts.

What happened to the merchant's bad-debt treatment? The merchant was considered paid when the account was sold or factored and could not take the described bad-debt deduction after paying the tax.

Was this a definitive approval of the proposed arrangement? No. The Comptroller said a representative purchase agreement had to be reviewed first.

Citations and references

• No statute or administrative rule is cited in the letter text.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/8712L0851A12

Original ruling text

COMPTROLLER OF PUBLIC ACCOUNTS
STATE OF TEXAS
AUSTIN, 78774

BOB BULLOCK
Comptroller December 10, 1987

Dear **:

Thank you for your recent letter which is restated with response below.

As per our conversation at the Taxpayers Service Seminar in
Abilene, Texas on Friday, October 30, 1987, I am requesting a
ruling in regard to a new business practice within the field of
debt collections.

Due to the new imposed Texas Sales Tax law that effects our
collection agency, our clients have become quite concerned about
the increase of their cost to collect delinquent account
receivables. I am sure you are aware that the collection agency
business is quite competitive and the profit margins are limited.
Therefore, the client recognizes the increased cost of being taxed
on collections and sometimes double taxed.

Numerous clients are concerned and expressing disappointment. It
seems as if the collection agency market is researching other
methods to maintain a reasonable return on delinquent debts without
bearing sales tax.

One method that is becoming very popular and quite competitive is
the purchasing of delinquent accounts. Our clients feel that this
method is very advantageous in that they would receive a guaranteed
rate of return on their delinquent accounts and avoid paying sales
tax.

Mr. Van Allen, this method is what I would like you to rule upon
regarding tax legality.

Is it a violation of any sales tax law for a collection agency
to purchase delinquent accounts from a client for an agreed
upon price and therefore avoid all Texas Sales Tax?

I need very desperately for you to contact me as soon as possible
regarding this ruling. I have a number of clients who are waiting
for me to receive this ruling so that we may purchase their
delinquent accounts. There are a number of collection agencies who
have already begun to utilize this method within their business.

Response: It is not a violation of the law for a collection agency
to actually buy a merchant's accounts receivable and collect their
own accounts. However, there are a few things you should know.

First, if your contract with the merchant provides for them to
purchase back uncollectible accounts we would consider it not to be
a true purchase and assess sales tax as a Debt Collection service.

Second, when a merchant sells or factors an account to you, the
state will consider the merchant to have been paid for the
transaction. As such, the merchant will not be allowed a bad debt
deduction if he has paid the tax and if he has not paid the tax, he
will be required to pay it on the original selling price of the
taxable item.

Third, before I could give you a definitive ruling, I would have to
review a representative sample of your purchase agreement.

This opinion is based on the facts presented. If there are additional or
different facts, the opinion may change.

If you have any questions or need more information, please call me at
1-800-252-5555 toll free from anywhere in Texas. The regular number is
512/463-4600. You may write me at the Tax Policy Division.

Sincerely,
Al Van Allen
Tax Policy Division