The proverb "neither a borrower nor a lender be" may work
well when it comes to personal relationships, but business is
built on credit. And where there is credit, there are
inevitably bad debts that cannot be collected. Most suppliers
account for VAT at the time the invoice is issued, before they
are paid. But if a supply on which VAT is due and on which VAT
has been declared goes wholly or partially unpaid, the EU VAT
Directive says that the taxable amount (the amount on which VAT
is declared) should be reduced.
This means the VAT that has been declared on it can also be
adjusted. Individual EU member states may determine the
relevant conditions, and they may also derogate completely from
that rule. So in essence, an EU member state does not have to
allow BDR, and if it does allow it, it can set the conditions
of any BDR claim. On the face of it, this seems to give an EU
member state the freedom to do as it likes when it comes to
BDR. However, this is not the case, as the discretion allowed
to an EU member state to curtail a taxpayer’s EU
rights by derogation is restricted by the requirement to adhere
to certain fundamental principles.
One of these is that a relief should not be excessively
difficult to secure. Another principle is that of equal
treatment. So once an EU member state decides to allow BDR, it
cannot, for instance, limit it to supplies where the unpaid
consideration is monetary rather than in kind – a
European Court of Justice (ECJ) decision which sheds some
useful light on the scope of that BDR derogation.
Landmark decision in Upper Tribunal
In August, the UK Upper Tribunal also concluded that certain
other BDR conditions which the UK previously imposed were also
outside EU law. These conditions were known as the insolvency
condition and the retention of title condition. Essentially,
from 1978 to 1997 the UK refused BDR for unpaid supplies of
goods, where title did not pass until full payment was made.
From 1978 to 1990, it also refused BDR unless the customer was
formally insolvent and, for part of that period, that the
supplier had also proved in the insolvency, by submitting his
claim in writing to the liquidator.
The Upper Tribunal decided that it was not proportionate to
apply one rule for supplies where title passed and another
where it did not. A debt can still be a bad debt in either
case, as it may not be possible for the supplier to secure the
return of his goods.
Additionally, while it might be reasonable to require proof
in insolvency before allowing BDR to be claimed for a large
debt, the UK rules imposed the insolvency condition on all
supplies, whatever their size. UK law also states that a
supplier cannot even seek to make its customer insolvent unless
the debts owed by the customer are over a certain minimum size.
The UK approach to BDR at that stage effectively made the
relief impossible to claim in some cases, and difficult and
expensive in others. These conditions were not proportionate
and they were discriminatory. They went beyond the discretion
envisaged by the Directive.
Although both GMAC and BT are open cases, the conclusions on
the UK’s old BDR conditions are acte
clair. That is, the Upper Tribunal is content that
Community law is sufficiently clear on this issue that a
reference to the ECJ is not needed.
Implications for other EU member states
So the question is – which EU member states allow
BDR? If it does, what conditions does it attach to the relief?
It is reasonable to make a supplier wait a while before the
debt can be considered bad, (the time limit in the UK is six
months), because any non-payment may be temporary, meaning the
debt is not bad. It is also reasonable to require certain
records of the bad debts to be kept, and to make a customer
repay any input tax credit it has taken for the supply they
have not and will not pay for. However, conditions that are
discriminatory, disproportionate or make the relief excessively
difficult to secure will not find favor. If applying the
process adopted by the UK Upper Tribunal to the BDR rules in an
EU member state where you are based, do the BDR conditions seem
disproportionate, discriminatory, or overly onerous?
Of course, another EU member state may not be bound by a UK
Tribunal decision, even one that sets a precedent in the UK.
But they are bound by the EU principles the Upper Tribunal has
explored and analysed. Therefore, the cases of GMAC and BT
could well have wider implications than just for UK supplies
made years ago, before the UK’s BDR rules became
The principles examined in GMAC and BT apply to supplies
made in EU member state, today, and could mean that taxpayers
have the right to claim BDR on supplies they previously thought
would have to remain unrelieved because of the terms of local
VAT law. Remember that a bad debt is one which has become
payable and remains unpaid and which the debtors either cannot
pay (because they have no means to do so) or which they simply
refuse to pay in circumstances where it is in commercial terms
not reasonable for the creditor to enforce. Where the parties
simply agree to adjust the consideration downwards, the
proportion of the original price that goes unpaid is not a bad
debt as it is not a debt at all.
If you would like to know more about this subject or any other
indirect tax matters concerning the UK, please contact:
Tel: +44 20 7311 2783