Goods and Services Tax Implications on Bad Debts
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Goods and Services Tax (GST) Implications on Bad Debts
The question of how GST handles bad debts arises frequently. Specifically, it concerns whether GST paid on supplies that result in irrecoverable debts can be refunded to the supplier. Bad debts pose a significant challenge for suppliers, especially when the tax has been paid but the customer fails to make the payment.
Here’s a detailed discussion on the treatment of such bad debts under the GST law for suppliers of goods who are liable to pay tax under forward charge.
Once the tax liability is triggered, the supplier must pay GST, irrespective of whether the payment has been received from the customer. If the customer defaults on payment, it leads to bad debts, but the GST law does not provide a mechanism to recover the tax paid on such bad debts.
Supply is made, Goods and Services Tax is paid but amount is not recoverable from Customer. In such case, whether amount of Goods and Services Tax can be refunded back. This issue has been addressed by the CBIC in a press release dated June 4, 2018.
What is the treatment of Bad Debts under GST?
Taxable Event and Time of Supply:
- The taxable event under GST is the supply of goods or services. The supplier’s liability to pay tax is determined by the Time of Supply (TOS) provisions.
Time of Supply for Goods (Section 12 of the CGST Act, 2017):
The liability to pay tax on the supply of goods arises at the earlier of:
- Date of issue of the invoice, or The last date on which the invoice is required to be issued under Section 31(1) of the CGST Act.
In case Goods involving movement: The date of removal of goods for supply to the recipient.
For goods not involving movement: The date of delivery of goods or making them available to the recipient.
Closer look at the implications on GST Paid on Supply
- The supplier must discharge GST liability as per the TOS provisions when the supply is made.
- GST is paid based on the invoice issued or goods delivered, even if the payment is not received.
- Given the current provisions under GST law, the supplier cannot reduce the GST paid due to non-payment by the recipient. The taxable event and the TOS provisions necessitate the payment of GST upon supply, irrespective of the actual receipt of payment from the customer.
- As per Section 34 of the CGST Act, 2017, the only method available to amend the already paid GST is to issue a credit or debit note. The CGST Act, 2017’s proviso to Section 34(2) states that if the tax incidence has been passed to another party, there can be no liability reduction. If items are returned, taxes paid exceed real tax liability, or bad debts result from inadequate service delivery, the GST paid on such amounts is refundable provided certain requirements are met. Consequently, GST that has already been paid on bad debts, as it is known in the business, cannot be adjusted.
- Proviso to Section 34(2) : This proviso restricts the reduction of GST liability if the tax burden has been passed on to the customer. Essentially, this means: “If the customer has accepted the invoice and the tax burden, the supplier cannot reduce their tax liability.”
CBIC Clarification on Bad Debts (FAQ No. 48)
Question No. 48: Where GST is charged on a supply of service and the amounts due from the customer become irrecoverable as a bad debt in commercial practice, would such GST paid on an accrual basis be refundable to the service provider by the Government?
Central Board of Indirect Taxes And Customs Clarification:
- The adjustment of GST already paid is allowed only by way of issuance of credit/debit note in terms of Section 34 of the CGST Act, 2017.
- Proviso to Section 34(2) of the CGST Act, 2017 states that no reduction in liability would be allowed if the incidence of tax has been passed on to another person.
- The only method to adjust GST already paid is through the issuance of a credit or debit note. This adjustment is subject to specific conditions:
- Credit note must be issued to the recipient of the goods or services.
- The recipient should acknowledge the credit note.
- If bad debts are due to a deficiency in the supply of services, GST paid on the same is refundable subject to the fulfillment of prescribed conditions. The GST paid may be refundable. This is contingent upon:
- Proof of deficiency in the supply.
- Meeting all other prescribed conditions for a refund under the GST law.
- Bad Debts in Trade Parlance: The common commercial practice of bad debts, where amounts remain irrecoverable due to customer default, does not allow for adjustment or refund of GST already paid. GST already paid on bad debts, as used in trade parlance, cannot be adjusted.
Practical Implications for Suppliers
Steps Suppliers Can Take to avoid Impact of GST on Bad Debts: Given the current provisions and clarifications by the CBIC:
- Strengthen credit control measures and due diligence before extending credit to customers. Suppliers should implement robust credit control measures to mitigate the risk of bad debts.
- Issue invoices promptly and ensure the accuracy of tax details to prevent future disputes.
- Maintain thorough documentation for all supplies and credit/debit notes to facilitate adjustments if applicable.
- Contractual Agreements: Include clear terms and conditions regarding payment and tax liabilities in contracts with customers.
- Regularly follow up on outstanding payments to minimize the risk of bad debts.
- Consider taking credit insurance to cover the risk of non-payment by customers.
- Pursue legal options for debt recovery in case of non-payment.
While the GST law does not currently provide relief for bad debts, these measures can help mitigate the financial impact on suppliers.
Conclusion
The current GST framework does not provide a mechanism to refund or adjust GST paid on bad debts arising from customer defaults. Suppliers should proactively manage credit and ensure compliance with documentation and contractual safeguards to minimize the impact of bad debts. The supplier cannot claim a refund or adjust GST paid. The bad debt is accounted for as a loss in the supplier’s financial records, but the GST paid remains as an outflow.
Thus, GST that has already been paid on bad debts, as it is known in the business sector, cannot be modified. You would pay the GST as soon as the invoice was issued. Bad debt only arises when the payments that are due are not paid even after considerable effort. Both the invoice’s value and the tax portion must be written down. Consequently, GST that has already been paid on bad debts, as it is known in the business, cannot be adjusted. You have to write off both the value of the invoice and also the tax portion