Tax Component of Bankruptcy ~ U-Tax Blog

Friday, August 3, 2018

Tax Component of Bankruptcy

Co-authored by Anton Havryk

Unfortunately, the Tax Code of Ukraine (hereinafter - the “Tax Code”) and the Law of Ukraine "On Renewal of the Debtor’s Solvency or Declaring Its Bankruptcy” (hereinafter - “Bankruptcy Law”) is not a well-tuned duet. There are many practical problems, when it comes to tax aspects of insolvency.

Below is the description of  three most common issues.

I. Initiation of bankruptcy procedure upon an application of the tax authorities

This question is in the first place relevant for taxmen themselves. The transfer of a tax debt from the category "not collected" to the category “being collected in the bankruptcy procedure” reduces the total taxpayers’ tax debt. This, in its turn, has a positive effect on the performance indices of the tax authorities.  

The problem exists, first and foremost, because the Bankruptcy Law (paragraph 2 of section 11) requires submitting a resolution on opening an enforcement proceeding as a prerequisite for the initiation of a bankruptcy procedure. There is also a requirement of the Bankruptcy Law that a three-month time-limit must elapse before the initiation of a bankruptcy proceeding is made starting from the date of the submission of the execution order for its enforcement.

As generally known, the procedure for collecting a tax debt does not entail the receipt of an execution order. For the sake of a tax debt to be collected based on the already rendered court judgement, the tax authorities address directly the bank of the taxpayer with their own collection order.  No resort to to the State Enforcement Service is needed on the part of the tax authorities.

Very fortunately for the tax authorities, courts do them a big favour by holding that in the case of the initiation of  a bankruptcy proceeding at the instance of the tax authorities the submission of a resolution on opening an enforcement proceeding is not  not mandatory.

The resolution of the High Economic Court of Ukraine (hereinafter - the “HECU”) of 17 February 2015 in case No 925/1941/14 is a striking example of such tax authorities-favorable court jurisprudence.  

II.  VAT on selling a bankrupt’s assets in a liquidation procedure

To date, the situation surrounding the VAT treatment on selling assets in a liquidation procedure continues to be controversial.

In particular, the HECU in its resolution dated 16 May 2012 in case No 25/112/10 ruled that during the sale of a bankrupt's assets in the liquidation procedure, the bankrupt incurs no output VAT.

Note that paragraph 1 (4) of section  38 of the Bankruptcy Law expressly provides that from the date of the adoption by the economic court of a ruling on declaring bankruptcy and opening of a liquidation procedure, the bankrupt does not incur any additional obligations (including taxes), except for the costs directly related to the implementation of the liquidation procedure.

At the same  time, the tax authorities support quite an opposite view. They treat the sale of of a bankrupt’s assets in the liquidation procedure as a VAT taxable transaction.

Paragraph 7.3 of section  7 of the Tax Code is a rather strong argument to bolster their position. Under this paragraph, no tax issue can be governed or changed by a  Law (Act) apart from that amending the Tax Code.

The aforesaid paragraph 4 part 1 of section  38 of the Bankruptcy Law is not incorporated into the Tax Code. Consequently, it cannot be considered as one exempting the transactions in question from VAT.

In practice, liquidators usually do not pay VAT when selling the assets of a bankrupt. However, the specified uncertainty has always been the  "Sword of Damocles" hung over the heads of the liquidators. There is always a risk of bringing the liquidators to criminal liability for tax evasion.

In 2015 there was an attempt to solve this problem on the legislative level. The Bill No  3164 dated 22 September 2015 “On Amendments to Section 184 of the Tax Code of Ukraine” was developed. The amendments  were concerned with subparagraph (d) of paragraph 184.1 of the Tax Code. According to the amendments the VAT deregistration  of a taxable person would have occurred not on the basis of a court order on the liquidation of that taxable person, but on the basis of a court order on the recognition of that taxable person a bankrupt.

However, for unclear reasons the Bill has been withdrawn, and the problem remains.

As of today, the work on eliminating the above discrepancy  continues on the legislative level. At present, the Tax and Customs Law Committee on of the Ukrainian Bar Association is working on a new Bill on amendments to the Tax Code.

III. Inclusion of the tax authorities’ claims to a register of creditors

There are three aspects of the problem.

First, is it possible to include to a register of creditors the tax authorities’ claims if the underlying tax liabilities are not due and payable yet?

Most economic courts take an unambiguous position that the tax authorities’ claims supported by not effective tax liabilities (including disputed notices of tax assessment) must not be  included in a register of creditors. The only tax debt which is either a tax liability agreed upon by the taxpayer himself or established by the court can be included in the register of creditors.  In particular, this position is articulated by the High Economic Court of Ukraine in its following resolutions: dated 20 December 2011 in the case No 5015/118/11; dated 8 October 2013 in case No 914/77/13 and dated 1 July 2015 in the  case No 914/1820/14.  

Second, what to do if the liquidation procedure is already over, but the tax liability has not yet become due and payable?

Sometimes, courts nevertheless include to the register of creditors tax liabilities that are not yet due and payable. However, if the court takes a position that a tax liability must become due and payable before being included in the register of creditors, then the liquidation procedure may end and the tax liability may not get to the register of creditors at all. If this is the case, the tax authorities will be able to write off such a tax liability as a  bad tax debt.

Third, a highly contentious question is how to treat the tax authorities’ claims whose underlying tax liabilities become due and payable after the opening of the bankruptcy proceeding.

In particular, this situation arises where  a notice of tax assessment was issued by the tax authorities before the opening of the bankruptcy proceeding. The taxpayer challenged the notice of assessment within the scope of the administrative or court  procedure. The appeal turned out to be unsuccessful for the taxpayer and the underlying tax liability became due and payable, but after the opening of the bankruptcy proceeding.

The question is whether such claim of the tax authorities should be counted as competitive or current insolvency claims?

On the one hand, it seems that such claims should belong to competitive insolvency claims. This conclusion can be drawn from the fact that the claims had arisen (the relevant notice of tax assessment had been issued) before the opening of the insolvency proceedings.

On the other hand, such claims became due and payable after the opening of the insolvency proceeding. Thus, they seem to be viewed as current insolvency claims.

Unfortunately,  there has not been enough court jurisprudence so far to give comprehensive answers to these difficult questions.
In the meanwhile, to say that there is no court jurisprudence at all is to say nothing.

An extremely interesting piece of court jurisprudence in this  context is the resolution of the HECU of 11 July 2012 in the case No 18/85 on the bankruptcy of  Molochna Rivyera, LLC.

In this case the HECU:

- acknowledged the claims of the tax authorities to pay tax liabilities, which became due and payable  after the opening of a bankruptcy proceeding to be competitive insolvency claims; and

- pointed out to the failure of the tax authorities to comply with a deadline set out for submitting competitive insolvency claims (the tax authorities submitted those claims after the underlying tax liabilities became due and payable in the liquidation procedure, rather than within the prescribed deadline in the administration of property procedure).

In lieu of conclusion

In sum,  bankruptcy  does really have a substantial tax component. Even despite the new, much more progressive wording of the Bankruptcy Law that took effect on  18 January 2013, there are still a great many tax problems in the area of bankruptcy.

No comments:

Post a Comment