Effective January 6, 2022, the Texas Comptroller of Public Accounts (“Comptroller”) adopted sweeping revisions to the bad debt provisions of 34 Tex. Admin. Code § 3.302 (Accounting Methods, Credit Sales, Bad Debt Deductions, Repossessions, Interest on Sales Tax, and Trade-Ins) (“Rule 3.302”). These mark the first amendments to Rule 3.302 in almost 20 years. The Comptroller enacted some controversial changes and also clarified some longstanding areas of confusion and conflict.
Bad Debts Sold to Third Parties; Additional Tax Due
Under certain conditions, Tex. Tax Code § 151.426 allows a seller to withhold payment or claim a refund or credit for sales tax on the unpaid portion of the sales price of a taxable item determined to be a “bad debt.” Two provisions of the statute, however, impose a continuing obligation to pay tax upon receipt of further payments. Subsection (b) generally requires a seller to report and pay additional sales tax if the seller receives further payment on an account previously determined to be a bad debt. Similarly, subsection (h) requires a “person” that previously claimed a credit or refund for a bad debt to report and pay additional sales tax “on any payments received on an account that has been written off and claimed as a bad debt.”
New Rule 3.302 extends a seller’s responsibility beyond these statutory requirements. The rule now purports to hold the seller liable for sales tax based on speculative, estimated future recoveries of bad debts that have been sold to third-party collectors. New subsection (d)(6) provides:
Post refund collection on a bad debt or sale of a repossessed item. A person who later collects any payment on a bad debt or sells a repossessed item for which a credit or refund was claimed must report the total amount collected or received from the sale as a taxable sale in the reporting period in which the collection or sale occurs, except when the previous credit or refund amount was calculated by estimating post-sale collections for sold accounts in accordance with subsection (d)(3)(E) of this section.
New subsection (d)(3)(E) provides:
Any person claiming a bad debt refund or credit must also account for all recoveries on an account. If the retailer or private label credit provider claims a refund or credit that includes accounts sold to a third party, the retailer or private label credit provider must provide the detailed collection amounts for sold accounts. If the person claiming the refund or credit does not have the actual collection information, the comptroller will estimate the post-sale collections in calculating the amount eligible for a refund or credit. The comptroller will estimate the post-sale collections at a rate of 2.5 times the proceeds from the sale of the account.
Under these new provisions, a seller’s bad debt refund, credit, or deduction is reduced by amounts that might, in the future, be collected by a third party to whom the bad debt was sold. The rule offers the retailer the option of perpetually maintaining “detailed collection” records for sold accounts or simply reducing the refund or credit based on a standard post-sale collection estimate of 2.5 times the amount for which the account was sold. In the preamble to the new rule, the Comptroller characterizes this formula as a “safe harbor estimate” of the amount of tax due from the seller.
During the notice and comment period prior to adoption of the rule, Ryan informed the Comptroller that these so-called “safe harbor” provisions exceed the Comptroller’s statutory authority. As noted above, the statute merely requires a seller to report tax when the seller subsequently collects on a debt and, likewise, requires payment of additional tax to the extent the person who previously claimed a refund or credit receives further payments on the account. The rule goes much further, purporting to make the seller liable for sales tax on any amount collected by a third party at any point in the future, after the seller has sold the debt and thus abandoned any opportunity to collect anything beyond the amount for which the debt was sold.
Once a debt has been sold, the seller is unlikely ever to know whether and when a third-party collector has recovered any part of it. Nevertheless, the rule obligates the seller either to (i) keep a detailed record of third-party collections in perpetuity, or (ii) reduce the bad debt credit or deduction up front using the 2.5 times “safe harbor estimate” of future collections.
Obviously, the “safe harbor estimate” will be the more attractive option for retailers that cannot account for third-party collections. This creates a windfall for the state of Texas at the expense of retailers and deprives them of deductions and credits to which they are lawfully entitled.
It is worth noting, however, that the buyer of the bad debt is not liable for sales tax on amounts recovered in connection with their purchase if the seller of the accounts (claimant of the refund) uses the “safe harbor estimate.” However, if the buyer receives the express assignment allowed under Rule 3.302(a)(2) when they purchase their accounts, they have a reporting requirement for subsequent collections if they request a bad debt refund.
No Division of Bad Debt Refunds
Rule 3.302(d)(2)(B) provides that “[o]nly one person is entitled to a credit or refund for sales and use tax paid to the comptroller on each bad debt or repossession.” This restriction did not exist in the prior rule. The rationale for this addition is not explained in the preamble to the proposed or adopted rule. It expressly bars multiple parties from seeking fractional credits or refunds associated with the same debt.
Local Tax Refunds May Be Assigned
Tex. Tax Code § 151.346 historically authorized bad debt deductions, credits, and refunds only for retailers. In 1999, however, the Legislature extended the opportunity to include persons who extend credit to purchasers under “a retailer’s private label credit agreement, or an assignee or affiliate of either…” Then, as now, Tex. Tax Code § 151.346(i) provides that a person other than a retailer may recover state sales and use tax but not local tax. New Rule 3.302(d)(4) clarifies that the retailer’s right to such local tax refunds may be expressly assigned to another person.
Statute of Limitations for Bad Debt Refunds
Subsection (d)(5) of the new rule provides that the statute of limitations for claiming a bad debt refund or credit is four years from the date a debt is charged off for federal income tax purposes. The previous Rule 3.302(d)(1)(B) provided that a bad debt refund or credit had to be claimed within four years from “the date the account is entered in the retailer’s books as a bad debt.” This change should make it easier to determine when the clock starts ticking on the claim.
Method of Claiming Refunds or Credits
Unlike the prior rule, new Rule 3.302(d)(7)(A) and (B) prescribe the allowable methods for claiming bad debt credits and refunds by permitted and nonpermitted persons. A person who holds, “or held at the time of the sale,” a Texas sales tax permit may either file a refund claim for tax paid on the bad debt or claim credit on the person’s sales tax report “only if the person files the tax report electronically and claims the credit in the reporting period in which the person’s books reflect the bad debt or subsequent reporting periods…” A nonpermitted person is limited to requesting a refund from the Comptroller. (This means the nonpermitted person may not obtain a sales tax permit and start taking credit on future tax reports for previously incurred bad debts.)
Proration of Partial Payments
Receipt of partial payments toward a bad debt raises allocation issues when the debt includes both the sales price of a taxable item and nontaxable charges, such as finance charges, late charges, and interest charges separately billed to the customer. Tex. Tax Code § 151.346(e)(2) provides that such partial payments must be “prorated between taxable and nontaxable charges…” Prior Rule 3.302(d)(2) provided that partial payments “may be applied ratably against the various charges that comprise the bad debt…” In Comptroller’s Decision No. 101,531 (2010), the Comptroller clarified that these provisions did not authorize the retailer to apply partial payments in any way it saw fit, but rather than the retailer must prorate partial payments in a manner that preserves the state’s interests. New Rule 3.302(d)(2)(C) explains exactly how the proration must be done and clearly favors the state’s interests over that of the retailer. It provides: “For a worthless account that includes charges for taxable and nontaxable items, payments on the account are applied to the charges occurring first in time and prorated between taxable and nontaxable charges occurring at the same time.”
Recordkeeping and Calculations on Uncollectible Accounts
In subsection (d)(8), the Comptroller tightened up the requirements for approval of alternative methods of recordkeeping and tax calculation on uncollectible accounts and made clear that Comptroller approval is prospective, only.
Accounting Methods
Subsection (c)(2)(D) of the new rule expressly allows retailers that keep their regular books on an accrual basis of accounting to report sales and use taxes on a cash basis. Subsection (b)(1) provides that a retailer that wants to use an alternative method of account “must” obtain the Comptroller’s prior written approval (the old rule said the retailer “should” obtain approval).
TECHNICAL INFORMATION CONTACTS:
Michael Garcia
Principal
Ryan
469.399.4173
michael.garcia@ryan.com
Tony Gulotta
Principal
Ryan
332.208.7060
tony.gulotta@ryan.com
The material presented in this communication is intended to provide general information only and should solely be seen as broad guidance and not directed to the particular facts or circumstances of any individual who may read this publication. No liability is accepted for acts or omissions taken in reliance upon the content of this piece. Before taking (or not taking) any action, readers should seek professional advice specific to their situation from Ryan, LLC or other tax professionals. For additional information about this topic, please contact us at info@ryan.com.
- Topics
- Tony Gulotta
- Transaction Tax
- Texas