Newsletter
CRITERIA OF CLAIMING BAD DEBT
Company A, a client of the firm, had accounts receivable overdue for two years without collecting any principal or interest. It issued demand letters through the post office, which complies with one of the requirements for claiming bad debts under the Income Tax Act (ITA). However, the National Tax Administration (NTA) asserted that Company A realized that the debtor was experiencing financial difficulties, but only issued demand letters for accounts receivable without taking more aggressive approaches, such as filing a lawsuit or applying for enforcement, to exercise its creditor's right. By applying the substance-over-formality principle, the NTA denied the existence of the accounts receivable, and denied Company A the right to claim them as bad debts. Objecting to the NTA's assessment, Company A decided to seek administrative remedies.
In the administrative proceedings, Lee and Li assisted Company A in reviewing the transaction vouchers between Company A and the debtor to substantiate the existence of the accounts receivable. We then analyzed the criteria for claiming bad debts, and found that Company A could meet the criteria either by acquiring proof of issuing a demand letter through the post office or proof of filing a lawsuit with a court. However, the NTA asserted that in order to meet the criteria for claiming bad debts, Company A, in addition to obtaining the certificate of issuance of the demand letters from the post office, must also submit evidence showing that Company A filed a lawsuit against the debtor or applied for enforcement against the debtor's assets, which is not required by law and contradicts the principle of taxation by law.
Furthermore, we cited academic opinions and the court's judgment, and argued that the application of the substance-over-formality principle does not prevail over the principle of taxation by law. Also, only when the NTA proves that Company A intended to evade tax by abusing the legal formality, leading to unfair taxation, would the substance-over-formality principle apply. In this case, since Company A categorized the overdue accounts receivable as bad debts, and did not alter the economic substance through legal formality to affect the tax that had to be paid, the substance-over-formality principle should not be applied.
The court accepted our argument, and held that the NTA's assessment should be revoked because it had misapplied the substance-over-formality principle and violated the principle of taxation by law.
The judgment not only demonstrated the courts' commitment to protecting taxpayers' rights, but also indicated that the NTA should not abuse the substance-over-formality principle in taxation. This case serves as a precedent for future cases involving unfair taxation by the NTA.