If a bank writes off a customer's unpaid credit-card balance and recourses (charges back) the uncollectible amount to the vendor, can the vendor claim a sales tax bad debt credit?

Subject

Bad Debts — Repurchase Of Factored Accounts Qualify For Credit If Vendor Is Obligated To Buy Back Bad Accounts

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9306056L

Plain-English Summary

This June 3, 1993 letter responds to a May 19, 1993 inquiry about sales tax on bad debts or worthless accounts. The requester described a common credit-card scenario: a vendor sells a taxable item, the end user pays with a credit card issued by a bank or other financial institution, and later the purchaser fails to pay the credit card bill so the account is written off the bank's books.

The requester asked whether either the vendor or the financial institution could get a bad debt deduction, and proposed two scenarios:

• Scenario 1: The financial institution identifies just the sales tax portion of the written-off account and recourses (charges back) that tax amount to the vendor. The vendor would then write the tax amount off as a bad debt and take a credit on its sales tax return.
• Scenario 2: The financial institution recourses the entire uncollectible receivable (the sales price plus the tax) back to the vendor. The vendor would then write off the whole amount and claim a bad debt deduction on its next sales tax return.

The Comptroller's office rejected Scenario 1 outright: tax itself is never allowed as a bad debt deduction. What is allowed as a bad debt deduction is the actual sales price of the tangible personal property (excluding tax), provided the other requirements of Rule 3.302 are met.

Scenario 2 may be acceptable, but only if three conditions are met: (1) the vendor is contractually obligated to buy back the bad accounts; (2) the vendor actually pays the financial institution the remaining amount due; and (3) the vendor claims the resulting bad debt deduction on its federal tax return. The vendor must also satisfy the requirements of subsection (d) of Rule 3.302.

What This Means For You

If you are a vendor whose customers pay by credit card

A bad debt sales tax credit is not automatic just because a bank writes off an unpaid credit card account. You can only claim the credit if the bank actually recourses the full uncollectible receivable back to you under a repurchase (factoring) arrangement — not merely a tax-only chargeback.

If your financing arrangement only recourses the tax portion

This letter says that approach does not work. Tax is never an allowable bad debt deduction on its own, so a vendor cannot take a sales tax credit simply because a bank identifies and charges back the tax component of a written-off account.

If you are considering a repurchase-of-factored-accounts arrangement

To qualify for the bad debt credit, make sure your agreement with the financial institution contractually obligates you to buy back bad accounts, that you actually pay the financial institution the amount due on those accounts, and that you claim the resulting bad debt deduction on your federal tax return. You must also meet the other requirements of Rule 3.302(d).

If you are an accountant or tax professional advising a vendor client

The dividing line in this letter is whether tangible personal property/receivables (not just the tax) are recoursed back to the vendor, and whether the vendor is contractually obligated to repurchase and actually pays for the bad accounts. Confirm all elements of Rule 3.302, including subsection (d), are documented before advising a client to take the credit.

Q&A

Q: Can a vendor take a sales tax credit just because a bank recourses the tax portion of a written-off account back to the vendor?
A: No. The letter states this scenario is not acceptable because tax is never allowed as a bad debt deduction.

Q: When can a vendor claim a bad debt credit on a factored/repurchased account?
A: When the vendor is contractually obligated to buy back the bad accounts, actually pays the financial institution the remaining amount due, and claims the resulting bad debt deduction on its federal tax return, subject to the other requirements of Rule 3.302(d).

Q: What is actually allowed as a bad debt deduction?
A: The actual sales price of the tangible personal property, less tax, when the other provisions of Rule 3.302 are met.

Q: What rule governs bad debt deductions for sales tax purposes in this letter?
A: 34 Tex. Admin. Code Rule 3.302, including its subsection (d) requirements referenced for the repurchase scenario.

Q: Who issued this letter and can I rely on it?
A: It was issued by Bettie Peterson of the Tax Administration Division. Per STAR's general disclaimer, letters can be relied on for detrimental reliance purposes only by the taxpayer to whom they were directly issued, and this opinion is expressly based on the facts presented — different facts could lead to a different answer.

Original ruling text

June 3, 1993

Dear Ms. **:

This is in response to your letter dated May 19,1993, regarding sales tax as it
relates to bad debts or worthless accounts.

One of your clients is a vendor who collects and remits sales taxes in Texas.
The end user purchases a taxable item using a credit card issued through a
financial institution. Later the original purchaser of the item fails to pay
the credit card bill and the account is eventually written off the books of the
financial institution.

Your client has asked that you determine whether there would be any conditions
where either the vendor or the financial institution could obtain a deduction
for the bad debt. You have devised two possible scenarios under which a
deduction could be obtained by the vendor. Your proposed scenarios are
paraphrased below.

SCENARIO 1

The financial institution is able to specifically identify the taxes
attributable to the written off account and the institution recourses this
amount (the tax) back to the vendor. The vendor would then write the tax off
its books as a bad debt and take this amount as a credit from its sales tax
return.

SCENARIO 2

The bank recourses the entire uncollectible receivable back to the vendor. The
vendor would then write off the entire amount and take a bad debt deduction on
its next sales tax return.

The first scenario is not acceptable. Tax is never allowed as a bad debt
deduction. The actual sales price of TPP, less tax, is what is allowed as a bad
debt deduction when the other provisions of Rule 3.302 are met.

The second scenario may be acceptable. A repurchase of factored accounts can
qualify for the bad debt credit if:

1. the vendor is contractually obligated to buy back the bad accounts;

2. the vendor actually pays the financial institution the remaining amounts
   shown to be -- due; and the vendor claims deductions on its federal tax returns
   for the bad debts resulting from such bought-back accounts. The vendor would
   then need to meet the requirements in section (d) of the enclosed Rule 3.302.

This opinion is based on the facts presented. Different facts, though similar,
might lead to different answers. If you have any questions or need more
information, please feel free to write or call 1-800-531-5441, my extension is
50330, or call 512-475-0330.

Sincerely,

Bettie Peterson
Tax Administration Division

May 19, 1993

Tax Administration
Comptroller of Public Accounts
Capitol Station
Austin, TX. 78774

To Whom It May Concern:

I am contacting you at the request of one of my clients who is seeking
clarification with respect to the portion of your sales tax statute related to
bad debts or worthless accounts.

The fact scenario being contemplated is as follows:

My client, a vendor which collects and remits sales taxes in your state, sells
a taxable item to an end user and the end user charges the purchase to his or
her credit card issued through a bank or other financing institution. Later,
the original purchaser of the item fails to pay his or her credit card bill and
the account is eventually written off the books of the bank or financing
institution.

In this scenario it appears that the vendor may not be able to claim a
deduction for a bad debt since the account has not been written off its books
and that the bank would not be entitled to the bad debt deduction since it did
not originally pay the tax to the state. However, since the sales tax related
to the sale was not ever paid by the original purchaser, one party to the
transaction should be entitled to the bad debt deduction since the taxes were
paid to the state but not collected.

With this scenario in mind, my client has asked that I determine whether there
would be any conditions in which either the vendor or the financing institution
could obtain a deduction for the bad debt. Based on a review of your state's
sale s tax statute I have devised two possible scenarios under which a
deduction could be obtained by the vendor and I am requesting that you provide
me with comments on which of these would be acceptable.

1) The first scenario in which I believe that the vendor may be able to receive
the bad debt deduction is a case in which the bank or financing institution is
able to specifically identify the taxes attributable to the written off account
and the bank or financing .institution recourses this amount to the vendor. In
other words, if the bank is able to identify that $100 of revenue and $5 of
sales taxes attributable to the vendor which became uncollectible, the bank
could recourse the $5 in written off taxes to the vendor. The vendor would then
write the $5 off its books as a bad debt and take this amount as a credit from
its sales tax return filed with the state.

2) The second scenario would be for the bank to recourse the entire
uncollectible receivable of $105 to the vendor. The vendor would then write off
the entire $105 and reflect a reduction of $5 on its next sales tax return
filed with the state.

Although I believe that either scenario should be acceptable since the end
result is the same, I would like your comments on whether one approach is
preferable to the other or whether either alternative is acceptable.

I appreciate your attention to this matter and look forward to a response to
this inquiry in the near future. If you have any questions or if you need any
clarification, please feel free to call me.

Sincerely,