Invoice factoring: how do you account for VAT?

Debt factoring

The term “factoring” covers a variety of services involving debt assignment, in which the factor provides you with finance in respect of debts owing from your trade debtors. The advantages to you 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.

Types of debt factoring

There are two main types of factoring; these are known as non-recourse and recourse. With non-recourse debt factoring the provider purchases the debt for a percentage of the invoiced amount and then owns the debt outright. For recourse debt factoring, the provider makes an advance of money to you but does not take ownership of the debt and can return it to you if it cannot collect it. This is the most common type of debt factoring, and typically involves a client account with a balance that can be drawn on.

Tax points

Where a business uses the standard tax point rules, a tax point is created by the issue of the invoice and VAT has to be accounted for at that time.

If a business uses cash accounting, request for payment or other method of deferring the accounting, the VAT becomes due when the factor provider collects the debt not when it pays you. This can provide a cash-flow advantage.

The provider will need to keep you informed of when the debts are collected. In the event that it can’t do this, HMRC allows you to bring forward the tax point to when the debt is assigned to the provider.

The initial advance made by the provider to you is not a payment for the purposes of the cash accounting scheme, it is simply treated as a loan.

Bad debt relief

If a business has issued an invoice that has not been paid six months after the due date for payment, it can normally claim bad debt relief (BDR) on the VAT element per VAT Notice 700/18. If debts are factored, BDR is not available where an assignment of the debt is absolute, i.e. non-recourse agreements.

Where there is provision for the reassignment of a debt, BDR will be available once the debt is reassigned to the business. No BDR can be available during the period in which the debt remains assigned to the provider. If you receive a payment from the provider for the unencumbered sale of a debt, this is considered to be an exempt supply of finance - and therefore will be disregarded for the purposes of BDR - so you will still be able to claim.