Legal nature of tax consequences of transactions of accounts receivable financing (factoring)

Accounts receivable financing, also called in the theory of the Russian civil law and everywhere in the law enforcement practice as factoring, is a transaction binding two subjects: the client - creditor under the good supply agreement, work or service agreements concluded with the debtor, as well as the fiscal agent-intermediary accepting the monetary claims against the debtor.

Despite the widespread belief that factoring is actively applied only in foreign trade transactions, it is not true. In fact, many Russian companies successfully use the possibilities of such kind of commercial transactions in their activities. As the officer of the Supreme Arbitration Court of the Russian Federation, PhD in law E.E. Shevchenko noted in his analytical work in 2008, the emergence of organizations-fiscal agents specializing in obtaining debts, offering insurance against the risk of non-payment and pre-financing, by itself is of great importance for the economy of Russia, for which a particularly acute problem is non-payment and generally inherent low level of financial discipline.

Legal regulation and practice of factoring relations in the Russian and international law

The basic meaning of factoring in both the Russian and international law is making the transaction of assignment of creditor of monetary claim against debtor in favor of the factor that, by paying the creditor the agreed value of assignment, acquires the rights to claim repayment of debt of debtor in its favor. In this case, there are certain differences between the international factoring, as a method of optimization of settlements on foreign trade transactions and accounts receivable financing, and it is impossible to consider these operations as equivalent ones.

Accounts receivable financing as transaction under the Russian law

According to the legal definition, under the agreement of accounts receivable financing the fiscal agent shall transfer or commits to transfer to the client funds on the account of the monetary claim of the client to third party (debtor), arising from the client providing goods, performing work or rendering services to third party, and client assigns or shall assign to the fiscal agent such monetary claim.
 
Schematically the transaction considered may be represented as follows:



* Hereinafter numbers designate transaction procedure.

From a legal point of view, accounts receivable financing (factoring in the understanding of the Russian law) is a particular case of change of persons in the liability on the part of the creditor (cession). Based on the legal provisions, the following features of factoring of relations compared to the cession relations can be distinguished:

1. Fiscal agent acting as assignee can only be a commercial organization.
At present, the Russian law has not developed a uniform practice of factoring relations, but given the existing law norms, we can conclude that factoring relations can only exist within entrepreneurial activity.
2. Factoring relations as optional financial obligations of the fiscal agent may provide for the obligation of accounting of client or providing it other financial services related to monetary claims that are the subject of assignment.

This means that the responsibilities of the fiscal agent may provide for a much wider range of functions than the assignee's obligations under the cession agreement.

Additional responsibilities of the fiscal agent may include, in addition to accounting, provision of other financial services. At the same their listing is complicated, since this term is not defined by the norms of civil law. The only fairly complete definition of financial service (set out in the form of a list only) contains the law on protection of competition. It means a banking service, insurance service, securities market service, service under leasing agreement or service provided by a financial organization and service related to raising and (or) placement of funds of legal entities and individuals . The main drawback in the use of the above list is the fact that the law on protection of competition regulates the norms of administrative rather than civil law. This suggests that applying the norm of law on protection of competition to the relations subject to the factoring agreement is incorrect.

An alternative approach may be considered the establishment of a list of additional services of fiscal agent on the basis of the list of functions of fiscal agent under the legislation on international factoring. These include the following:

• financing of supplier, including loans and advances;
• maintenance of accounts related to receivables;
• collection of accounts receivable;
• protection against insolvent debtors.

This approach seems more appropriate from the point of view of the Russian civil law , but significantly limits the possibilities of application of the provisions on additional financial services under the factoring agreement.

In this regard, upon signing agreements on accounts receivable financing it makes sense to clearly define what additional services provided by the fiscal agent refer to additional financial services included in the subject of the relevant transaction.

3. Provision of most additional financial services, especially if we consider the term on the basis of the concept of the law on protection of competition, implies limitation of the subject composition of fiscal agents. Thus, the activity of banks and other credit organizations is subject to license, for a commercial organization to be able to do insurance business an appropriate license is required as well, leasing companies are subject to a number of requirements as to the business reputation of their heads.

International Factoring

International factoring is a kind of factoring transaction that ensures settlements and service support of financing supplies of goods and services with deferred payment in circumstances where the supplier and the buyer are residents of different states. International factoring, as opposed to the trade financing transactions, is used to work on a long-term or indefinite foreign trade contracts, characterized by regular supplies and a tendency to increase in turnover.

Legal basis of international factoring are formed on the basis of the UNIDROIT Convention on International Factoring. The Convention defines the international factoring, as well as the material terms of such transaction, provided the parties to the contract have not taken a decision not to apply the provisions of the convention to their relations.
 
The principle shceme of international factoring in accordance with the Convention has the following form:



Comparing the features of international factoring carried out on the basis of the Convention, with the transactions of accounts receivable financing under the legislation of the Russian Federation, the following specific features of international factoring can be identified:

1. International factoring in accordance with the Convention can be made only with respect to debt of buyers that purchase goods for business purposes. It can not refer to the debt under the agreements, the subject of which is performance of works or provision of services, as the understanding of accounts receivable financing under Russian law allows believing.

As a whole there are no obstacles to using factoring relations under international agreements for performance of works or provision of services, but they can not be covered by the regulation of the Convention norm.

2. As opposed to the Russian version, in the international factoring the obligations of the factor can be expressed not only in the acquisition of monetary claim, but also in the performance of other obligations, the result of which is the timely repayment of obligations of buyers to the creditor. According to the Convention the factor may be entrusted to perform any two of the following obligations:

• supplier’s financing in any possible way, including besides advances the provision of loans;
• maintenance of accounts relating to receivables;
• collection of receivables for the supplier;
• protection of buyers against insolvency.

The UNIDROIT Convention on international factoring is currently not entered into force for Russia, but is already ratified.

In practice, according to the Ministry of Economic Development of the Russian Federation, the two most common models of international factoring are one-factor and two-factor transactions.

In case of one-factor model the fiscal agent acts only on behalf of one party to the agreement (in most cases - on behalf of the creditor) only, while the factor and the client are residents of the same state. The scheme of the one-factor model of international factoring is not different from the standard scheme of international factoring, as shown in figure 2 above, except for the addition that the supplier and the factor under it must be residents of the same state:



The two-factor model involves participation in the transaction of two fiscal agents, one of which is resident of the state of the supplier, and the other of the state of the buyer. Accordingly, the first factor (the so-called “export factor”) is involved by the supplier, and the second (the so-called “import factor”) – by the buyer.

Below is a scheme of the two-factor model of transaction:



A particular attention shall be paid to the relations between the export-factor and the import-factor. The interaction of these elements of the two-factor model of transaction should be carried out within the framework of one of the international factoring associations. The factor, acting on behalf of the Russian company, must be member of the following associations: Factors Chain International or International Factors Group.

Protection of interests of the factor in the accounts receivable financing

Depending on which party of the factoring relationship - the client (creditor) or the factor - assumes the risk of non-payment by the debtor, there are two types of agreements of accounts receivable financing: recourse and non-recourse factoring agreements.

Non-recourse Factoring Agreement

As a general rule, which, however, can be changed by agreement of the contractual parties, the accounts receivable financing exempts the client from the risks associated with the insolvency of the debtor. The dispositive norm of the Civil Code of the Russian Federation provides that the client is not responsible for any failure or improper performance of the debtor of the claim that is the subject of the assignment, in case it is submitted by the fiscal agent for execution, unless otherwise agreed by the parties of the factoring agreement.

Recourse Factoring Agreement

Under the recourse factoring agreement the factor, financing the creditor, assumes no risk of default of the debtor. If for any reason the debtor has not paid to the factor, the liability to the factor for such default passes to the client.

In practice, there are also some specific transactions, the qualification of which is complicated for the parties, as well as for courts. Thus, on 30 April 2014 the Supreme Arbitration Court of the Russian Federation upheld the decision of courts of the second and third instances on re-qualifying the recourse factoring agreement as non-recourse one. The basis for such re-qualification was the fact that along with the factoring agreement the parties had also signed an agreement of surety of the client for the debtor. In this situation, the court found that the factoring agreement was concluded without recourse, the factor undertook the risks of non-payment by the debtor and the surety agreement was a separate transaction not related to factoring.

Tax consequences of factoring

Value Added Tax (VAT)

Numerous examples of judicial practice confirm that the relations between the participants to factoring transactions relate to transactions not subject to VAT under the laws of the Russian Federation.

In this case, however, it should be taken into account that if under the factoring agreement the fiscal agent provides additional services to the client, for example, accounting services, and the price of such services is allocated in the price of factor services, their implementation will be recognized as a separate subject to VAT.

Corporate Income Tax

To determine the date of receipt by the factor of income in the form of right to claim assigned to it, the tax legislation of the Russian Federation contains a special requirement. Such income is recognized received at the time of performance of the debtor of its obligations to the factor as to the new creditor or at the time of enforcement of the factor of the right to claim against third party obtained by it.

In turn, the revenue of the client (creditor) from the sale of the property right considered is recognized for the purposes of tax of profits from sales. The client (creditor), enforcing its right to claim against the debtor receives income in the value of this property right as agreed by the parties to the factoring agreement, and the cost (in this case - losses) - in the amount payable by the debtor.

Upon assignment of the right to claim by the creditor, which determines income and expenses on an accrual basis, the date of receipt of assignment of the right to claim is defined as the date of signing by the parties of the certificate of assignment of the right to claim . For the purposes of corporate profits tax on income in the form of accounts receivable financing, the date of recognition of income (loss) from assignment of the right to claim will be recognized as the date of signing of the agreement on assignment of the right to claim.

The creditors using the cash method of determining the income and expenditures recognize the income and losses obtained at the time of actual receipt of funds from the factor.

Despite the fact that the recourse and non-recourse factoring agreements differ significantly in their legal nature, the law does not distinguish them by date of determination of income.

Some authors are inclined to believe that the recourse factoring agreement shall be considered as one of the varieties of the (credit) loan agreement provided the repayment may be made a third party (debtor). So, in fact, the factoring agreement qualifies as a loan (credit) agreement, and the funds obtained under it are not recognized as income of the creditor until the parties confirm in writing the performance of the payment by the debtor in favor of the factor. However, this approach is not confirmed by law enforcement practice.