en
Taxation of the amount of accounts receivable with an expired statute of limitations
Taxation of the amount of accounts receivable with an expired statute of limitations
According to Article 166.1.3 of the Tax Code, the moment when the statute of limitations expires for receivables arising from the supply of goods (works, services) is determined as the time of the VAT-taxable transaction. However, how is the expiration of the statute of limitations applied in the calculation of VAT and profit tax? This issue is explained by tax expert Javid Valizade.
Pursuant to Article 111 of the Tax Code, if income related to the supply of goods, performance of works, and provision of services has previously been included in the total income obtained from entrepreneurial activity, the taxpayer has the right to deduct the amount of the related bad debt from income. Deduction of the bad debt amount from income is allowed at the moment when such bad debt is written off as a worthless debt in the taxpayer’s accounting records.
The commencement and suspension of the statute of limitations, as well as its expiration, are regulated by the Civil Code. According to Article 372 of the Civil Code, the right to demand that another person perform or refrain from performing a certain action is subject to a time limit. The period established for the protection of a violated right by filing a claim is considered the statute of limitations.
The statute of limitations begins to run from the day the right to claim arises. The right to claim arises from the day when the person knew or should have known about the violation of their right. For contractual claims (i.e., receivables/debtors), the statute of limitations is set at three years.
Example 1: The amount of accounts receivable owed by “BB” LLC to “AA” LLC is 500,000 manats. Due to the failure of “BB” LLC to repay its debts, the counterparty applies to the court before the expiration of the statute of limitations (i.e., within three years). The court issues a decision recognizing this amount as a bad debt of “AA” LLC due to the insolvency of “BB” LLC.
In this case, the VAT liability of “AA” LLC will amount to 90,000 manats:
500,000 × 18% = 90,000 manats.
Since this amount was recognized as income in previous years, 500,000 manats will be recorded as a bad debt expense in the current year and will be taken into account in the calculation of profit tax.
It should be noted that if an application is submitted to the court within the statute of limitations period for the purpose of collecting the receivable, and the debt is recognized as a bad debt by a court decision, it may be written off in accordance with the procedure established by law.
Example 2: “BB” LLC is a debtor of “AA” LLC. The amount of accounts receivable owed by “BB” LLC to “AA” LLC is 500,000 manats. “AA” LLC did not claim the debt in a timely manner, and since the statute of limitations expired, it was unable to apply to the court. In this case, the VAT liability of “AA” LLC will amount to 90,000 manats:
500,000 × 18% = 90,000 manats.
Although this amount was recognized as income in previous years, “AA” LLC will not be able to record 500,000 manats as a bad debt expense in the current year, because without a court decision this debt is not recognized as a bad debt. Therefore, when calculating profit tax, this amount cannot be deducted from income.
As can be seen from the examples, in both cases VAT must be paid to the state budget. The recognition of bad debts as expenses depends on the existence of a court decision.
According to Article 166.1.3 of the Tax Code, the moment when the statute of limitations expires for receivables arising from the supply of goods (works, services) is determined as the time of the VAT-taxable transaction. However, how is the expiration of the statute of limitations applied in the calculation of VAT and profit tax? This issue is explained by tax expert Javid Valizade.
Pursuant to Article 111 of the Tax Code, if income related to the supply of goods, performance of works, and provision of services has previously been included in the total income obtained from entrepreneurial activity, the taxpayer has the right to deduct the amount of the related bad debt from income. Deduction of the bad debt amount from income is allowed at the moment when such bad debt is written off as a worthless debt in the taxpayer’s accounting records.
The commencement and suspension of the statute of limitations, as well as its expiration, are regulated by the Civil Code. According to Article 372 of the Civil Code, the right to demand that another person perform or refrain from performing a certain action is subject to a time limit. The period established for the protection of a violated right by filing a claim is considered the statute of limitations.
The statute of limitations begins to run from the day the right to claim arises. The right to claim arises from the day when the person knew or should have known about the violation of their right. For contractual claims (i.e., receivables/debtors), the statute of limitations is set at three years.
Example 1: The amount of accounts receivable owed by “BB” LLC to “AA” LLC is 500,000 manats. Due to the failure of “BB” LLC to repay its debts, the counterparty applies to the court before the expiration of the statute of limitations (i.e., within three years). The court issues a decision recognizing this amount as a bad debt of “AA” LLC due to the insolvency of “BB” LLC.
In this case, the VAT liability of “AA” LLC will amount to 90,000 manats:
500,000 × 18% = 90,000 manats.
Since this amount was recognized as income in previous years, 500,000 manats will be recorded as a bad debt expense in the current year and will be taken into account in the calculation of profit tax.
It should be noted that if an application is submitted to the court within the statute of limitations period for the purpose of collecting the receivable, and the debt is recognized as a bad debt by a court decision, it may be written off in accordance with the procedure established by law.
Example 2: “BB” LLC is a debtor of “AA” LLC. The amount of accounts receivable owed by “BB” LLC to “AA” LLC is 500,000 manats. “AA” LLC did not claim the debt in a timely manner, and since the statute of limitations expired, it was unable to apply to the court. In this case, the VAT liability of “AA” LLC will amount to 90,000 manats:
500,000 × 18% = 90,000 manats.
Although this amount was recognized as income in previous years, “AA” LLC will not be able to record 500,000 manats as a bad debt expense in the current year, because without a court decision this debt is not recognized as a bad debt. Therefore, when calculating profit tax, this amount cannot be deducted from income.
As can be seen from the examples, in both cases VAT must be paid to the state budget. The recognition of bad debts as expenses depends on the existence of a court decision.