VAT Refund for Bad Debts

The Legal Framework
The legal basis governing VAT refunds in Israel is the Value Added Tax Law, 1975 (the “VAT Law”). Section 49 of the VAT Law permits the correction or cancellation of a VAT invoice when a transaction has not been completed, is canceled, or when there is an error in the invoice. This section particularly applies in cases where the customer has not paid the consideration or has not paid the full amount.

According to Regulation 24A of the Value Added Tax Regulations, 1976, a claim for a VAT refund on a bad debt may be submitted if the application is filed within three years from the date the VAT invoice was issued. Regulation 24A(c) further stipulates that the VAT refund will only be granted if the debt is deemed bad and it must be proven that all efforts to collect the debt, including legal actions such as enforcement, bankruptcy proceedings, or debt write-offs under a creditors’ arrangement, have been exhausted by the business.

Conditions for Recognizing a Debt as a Bad Debt for VAT Refund Purposes
The process for claiming a VAT refund for a bad debt requires compliance with specific conditions. The business must prove the following:

1. Transaction Execution: The transaction must be between a business and a customer, which obligates the business to pay VAT on the transaction.
   
   
2. Issuance of VAT Invoice: The business must issue a VAT invoice for the transaction. This invoice serves as evidence that the transaction took place and VAT was paid.
   
   
3. VAT Payment: The VAT paid to the tax authorities for the transaction forms the basis for the refund.
   
   
4. Non-collection of Consideration: It must be demonstrated that the business was unable to collect the consideration or that part of it was not paid.
   
   
5. Debt Becoming Bad: The business must prove that the debt is uncollectible, meaning the debt arose in cases such as the customer’s bankruptcy, failure to collect through enforcement proceedings, or debt forgiveness in a creditors’ arrangement.
   
   

Submission of a VAT Refund Application
The application for a VAT refund due to a bad debt is submitted to the VAT department. The business must provide the following documents:

1. Credit Invoice: An invoice that reduces the amount agreed upon to collect from the customer.
   
   
2. Supporting Documents: Documents proving that the debt is indeed bad, such as court rulings regarding the debtor, enforcement reports, or documents related to debt settlements.
   
   

The application for the VAT refund must be submitted within a time frame of six months to three years from the issuance of the VAT invoice, in accordance with Regulation 24A. The regulation sets a strict time limit but allows for exceptions. In cases of special circumstances, an extension may be granted for submitting the application.

Time Limits and Legal Flexibility
As noted, Regulation 24A(c) imposes a three-year time limit for submitting a refund application. However, case law indicates flexibility and the ability to extend the time limit in exceptional circumstances, such as delays in collection proceedings or lack of awareness of the bad debt.

In the case Tzintziper (C.A. 3498/21), the court ruled that the time limit for submitting a VAT refund application could be extended in cases where the business was unaware of the bad debt in real-time or where enforcement proceedings did not yield positive results. The ruling emphasized principles of proportionality and flexibility, enabling businesses to deal with situations where the debt became bad after the expiration of the period.

Insurance Reimbursement for Bad Debts
In a recent ruling dated February 3, 2022, the Tel Aviv District Court accepted the appeal of Tnuva Ltd. (C.A. 39314-06-19), which argued that the insurance compensation received from an insurance company for a bad debt does not negate its right to a VAT refund. In this case, Tnuva had purchased a credit insurance policy, which included coverage for bad debts related to customers who failed to pay.

Tnuva marketed products to Mega Retail Ltd., which entered bankruptcy proceedings in 2016, leaving a debt of 100 million NIS. The insurance company paid Tnuva approximately 85 million NIS. The court ruled that insurance compensation does not constitute “payment for the transaction” and, therefore, does not invalidate Tnuva’s right to a VAT refund for the bad debt. Even if insurance compensation was received, the bad debt is still considered uncollectible, and Tnuva’s right to a VAT refund is preserved.

Practical Implications and Tax Policy
The practical implications of this interpretation are critical for business owners, as they can be assured that receiving insurance compensation will not deny them the right to claim a VAT refund for bad debts. Furthermore, in cases where the debt has become bad, a VAT refund may be due even if the customer did not pay the consideration, but insurance reimbursement was received.

The VAT Interpretation Circular 2/2012 issued by the VAT Department provides that if the business succeeds in collecting the consideration (wholly or partly) from any source, including an insurance company, it is considered as liable for VAT at the time of receipt. However, insurance compensation is not considered a taxable transaction, and thus the insurance company is not regarded as a third party settling the debt.

Conclusion
The VAT refund for bad debts is an important mechanism for businesses, but it must be carried out in an orderly and accurate manner, in compliance with the conditions set by law and regulations. The VAT refund will not be affected even if insurance compensation is received, and the business may still submit a refund application if it has received insurance reimbursement for the bad debt.

It is recommended that businesses seek professional legal advice to ensure the timely submission of applications and avoid legal difficulties.

Yaniv Ish-Shalom & Co. Law Office specializes in civil and criminal tax law and provides professional advice and representation to businesses in matters related to VAT refunds for bad debts.

For more information and to schedule a personal consultation, please contact our office.