Credit, debts and related services: debts and related services: factoring (including invoice discounting)
The term ‘factoring’ covers a variety of services involving debt assignment (often referred to as the purchase of debts), which the factor may provide to clients in respect of debts owing from their trade debtors. The advantages to the client may include some or all of the following:
- immediate finance (the up-front payment of, typically, 80% of the debt)
- protection against bad debts
- sales ledger administration
- a debt collection service, from initial contact with the debtors through to legal enforcement
- provision of credit information on customers
- provision of legal advice and
- provision of management information.
A variety of terms are in use but the products the factor offers his client may include the following:
- Full Service (also known as non-recourse, old line, main line or traditional factoring): the factor is assigned the debt (which is disclosed to the debtor), opens a line of credit to the client, provides a full sales ledger service, sends debtors notices of assignments, undertakes recovery action and bears the loss if the debtor defaults in certain circumstances.
- Recourse factoring: as for the Full Service except that the factor does not bear the loss if the debtor defaults but has the right to assign the debt back to the client.
- Maturity factoring: the non-recourse service but without the provision of the line of credit for an immediate payment on account. Payment in full of the purchase price is made either upon receipt from the debtor or at the end of a fixed ‘maturity period’. This is usually based upon prior overall collection period of the entire ledger.
- Agency factoring (sometimes known as bulk factoring or agency discounting): the factoring arrangement is disclosed to the client’s debtors; the factor extends the line of credit but does not bear any loss. The client operates his own sales ledger and debt recovery system as the agent of the factor.
- Invoice discounting (also known as confidential factoring or undisclosed factoring): as for agency factoring but the factoring arrangement is not disclosed to the debtor. Can be with or without recourse.
- Undisclosed factoring: an invoice discounting arrangement with a limited debt protection facility - the factor agrees to bear a proportion of unrecoverable debts.
You may also find further variants of the above.
The factoring process
The factor typically takes an equitable assignment of his client’s debts. This gives him certain legal rights without full legal ownership of the debt; it enables him to pursue the debt and, in the event of the client’s insolvency, gives him preferential rights over the income from the debt. Historically the factor did not take a legal assignment of the debt since this incurred stamp duty. This is likely to continue even though stamp duty has been abolished on the assignment of debts.
Under his agreement with the client the factor may act on a recourse or non-recourse basis. In a recourse agreement he will, if the money cannot be recovered from the debtor, reassign the debt back to the client. In a non- recourse agreement the factor will bear the loss in the absence of any breach of the agreement between the factor and his client.
The factor opens a client account ( sometimes called a ‘current account’) to which he credits the face value of the debts he has bought and debits his charges (these may be consideration for a number of standard rated supplies of administrative, clerical and accounting services). The balance, less an agreed retention, is available for the client to draw upon. The factor debits to the account any payments to the client and also a finance charge, sometimes described as a ‘discount’, ‘discount charge’ or ‘discounting charge’.
Article 135.1 (d) of the VAT directive specifically excludes debt collection and factoring from exemption:
|Transactions, including negotiation, concerning … but excluding debt collection and factoring|
Prior to this, Article 13B(d)(3) of the Sixth VAT Directive specifically excluded both debt collection and factoring from the exemption. When the Directive was recast into its current form however it was agreed that, as factoring was in any event a form of debt collection, it was not necessary to include the words ‘and factoring’ in the new version. Services of factoring and debt collection are therefore liable to VAT at the standard rate. The decision of the ECJ in the appeal of MKG-Kraftfahrzeuge-Factory GmbH (‘MKG’ - C-305/01 ( STC 951) confirmed that the supply of factoring is essentially taxable.
In GKFL Financial Services AG (“GKFL”- C-93/10) the ECJ held that an operator who purchases defaulted loan receivables at its own risk and at a price below their face value does not make a supply of services for a consideration for VAT purposes.
The ECJ considered whether, as a purchaser of debts, GKFL was providing some form of debt collection service back to the bank that sold the debt (i.e. following the ECJ judgement in MKG – see above) for which the consideration would have being the deduction made from the face value of the debt in calculating the purchase price.
The ECJ concluded that GKFL did not receive any consideration from the bank, as the difference between the purchase price of the debts and their face value was merely a reflection of the actual economic face value of the debts at the time of purchase.
By contrast, in the case of MKG, the assignee of the debts did make a supply of services to the assignor because it received consideration for those services by way of a factoring commission and a del crede fee.
Where a factor provides credit in that the client can, as explained above, draw upon the account for which it is charged interest it will take the form of a ‘discount’, ‘discount charge’ or ‘discounting charge’.
For the VAT treatment of the ‘discount’ and other factoring related services please see paragraph 5.5 in VAT Notice 701/49 Finance
Place of supply
A UK factor may rely upon an overseas associate to collect a debt or may provide such services himself within the UK for an overseas factor. To determine the place of supply please see VATPOSS.
Partial exemption, bad debt relief and cash accounting
Please see VAT Notice 701/49 Finance, section 5 with regard to partial exemption, bad debt relief and cash accounting.