Kentucky – Retailer Not Entitled to Bad Debt Deduction

SALT Report 1822 – The Kentucky Board of Tax Appeals ruled that a Taxpayer, who operates a chain of home improvement stores across the United States, was not entitled to write off bad debts it incurred as a result of defaulted private label credit card payments.

The Taxpayer contracted with a third party finance company to handle its private label credit card program (PLCC).  The Taxpayer paid the finance company a service fee for administering the program.  According to the terms of the agreement, when a customer makes a purchase with the Taxpayer’s credit card, the finance company advances the purchase price and sales tax to the Taxpayer, minus a service fee, and the customer receives the merchandise.  The Taxpayer is obligated to remit the sales tax that was collected from the customer to the Department of Revenue.

If the finance company later determines that the debt has become uncollectible, the finance company can write off the debt on its federal income tax returns.  The Taxpayer does not have the right to collect the debt from the customer or to write the bad debt off on its income tax returns. Instead, the Taxpayer may choose to file a request for refund of the sales tax remitted to the Department.

Kentucky law, KRS 139.350, allows a Taxpayer to write off a bad debt if it is the owner of the debt and has the legal right to deduct debt from its income tax returns.  The KBTA ruled that the Taxpayer had not met the statutory requirements to recover the bad debt because:

  • It is not the owner of the debt
  • It had not written off the bad debt as a loss on its books, and
  • It had not it written off the bad debts on its income tax returns

The Taxpayer appealed the decision claiming that the state was being unjustly enriched by keeping the sales tax. The KBTA rejected the Taxpayer’s unjust enrichment argument stating that “sales tax is levied with respect to a consummated sale, and the subsequent default by a consumer on a debt does not undo that original sale that triggered the tax obligation. The statutory bad debt deduction is merely an authorization by the legislature to grant a deduction to certain taxpayers in certain circumstances and the plain meaning of the statutory requirements must be followed in order for the deduction to be applicable.” Consequently, the Taxpayer’s request for refund was denied.

As previously reported in SALT Report 1815, the same retailer was denied a bad debt reduction on its transaction privilege tax return in Arizona.

For Further Information:

Kentucky Board of Tax Appeals – Final Order # K-22609

SALT Report 1815 – Arizona – Bad Debt Deductions on Transaction Privilege Tax Returns