Must a lessor report sales tax when litigation or a guarantor later pays part of a lease debt written off as bad debt?

Plain-English summary

Virginia required the lessor to report later litigation settlements and guarantor payments on the first sales-tax return filed after collection. A bad-debt write-off did not make a later recovery permanently tax-free.

Va. Code § 58.1-621 allowed a dealer to credit previously returned and paid sales or use tax on an account found worthless. If that account was later paid in whole or part, the amount collected had to be included on the next return.

In the first scenario, a customer defaulted on a 60-month lease, leaving a $55,000 deficiency that was charged off. Sales tax had been remitted on monthly payments. Any later litigation settlement or third-party guarantor payment had to be reported and taxed when collected.

In the second scenario, equipment under a 60-month lease with a $1 purchase option was sold to an unrelated third party after default. A $25,000 net deficiency remained and was charged off. Later recoveries of $8,000 through judgment or $2,000 from another guarantor likewise had to be reported on the first return after collection.

What this means for you

• Track each bad-debt credit back to the underlying taxable account.
• Flag recoveries from customers, courts, guarantors, insurers, or other third parties.
• Report the recovered amount on the first return after collection.
• Keep settlement and deficiency calculations that separate the sales price, tax, and nontaxable charges.

Common questions

Q: Does it matter whether payment comes from the customer or a guarantor?
A: No. The ruling applied the collection rule to both litigation proceeds and third-party guarantor payments.

Q: What if equipment was sold and only a deficiency remained?
A: A later collection of the charged-off deficiency still had to be reported.

Q: When was the recovery reported?
A: On the first return filed after collection.

Citations and references

• Va. Code § 58.1-621.

Subject

Receipt of funds from litigation of leasing contracts and funds from third party guarantors.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 12-208

Original ruling text

December 13, 2012

Re: Request for Ruling: Retail Sales and Use Tax

Dear *:

This is in reply to your letter submitted on behalf of * (the "Taxpayer"), in which you request a ruling regarding the application of the retail sales and use tax to funds received after a bad debt has been charged off. I apologize for the delay in responding to your letter.

FACTS

The Taxpayer entered into leasing contracts with customers. Customers defaulted on the leasing contracts and the balance was charged off or in some instances the property was sold to a third party for a price on which sales taxes were collected leaving a balance due that was charged off to bad debts. In each scenario the Taxpayer questions the application of the sales tax to the receipt of funds from the litigation of the leasing contracts or the subsequent receipt of funds from third party guarantors.

RULING

Virginia Code § 58.1-621 that sets out the following provisions:

In any return filed under the provisions of this chapter, the dealer may credit, against the tax shown to be due on the return, the amount of sales or use tax previously returned and paid on accounts which are owed to the dealer and which have been found to be worthless within the period covered by the return. The credit, however, shall not exceed the amount of the uncollected sales price determined by treating prior payments on each debt as consisting of the same proportion of sales price, sales tax and other nontaxable charges as in the total debt originally owed to the dealer. The amount of accounts for which a credit has been taken that are thereafter in whole or in part paid to the dealer shall be included in the first return filed after such collection . (Emphasis added.)

Scenario 1

A lessee has defaulted on a 60 month lease leaving a deficiency balance of $55,000.00, which has been charged off to bad debts. Sales tax had been remitted on each monthly lease payment. Subsequently, the Taxpayer receives a settlement from litigation or a settlement amount from a third party guarantor. Based on the wording of the statute, the Taxpayer must report the amount received on its first return after such collection and compute the tax on such amount included in its return.

Scenario 2

A lessee has defaulted on its 60 month lease agreement with an option to purchase at the end of the lease for $1.00. Sales tax had been remitted on each monthly lease payment. After the Taxpayer has sold the equipment to an unrelated third party, a net deficiency of $25,000.00 remains unpaid. The Taxpayer charges this amount off to bad debts. Subsequently, through litigation, the Taxpayer receives a settlement for $8,000.00 as a final judgment, or receives $2,000.00 from another guarantor. Again, based on the wording of the statute, the Taxpayer must report the amount received on its first return after such collection and compute the tax on such amount included in the return,

I trust that the foregoing responds to your ruling request. This response is based on the facts provided as summarized above. Any change in the facts or the introduction of new facts may lead to a different result.

The Code of Virginia section cited is available on-line in the Laws, Rules and Decisions section of the Department's website located at www.tax.virginia.gov. If you have any questions regarding this matter, please contact * of the Department's Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

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