Laws, Regulations & Annotations
Business Taxes Law Guide – Revision 2016
Sales and Use Tax Annotations
130.0007 Claims for Refund for Earned Interest on Bad Debts. Regulation 1642, as amended September 26, 2002, allows lenders under certain conditions to claim a bad debt loss on accounts that are found to be worthless and are written off for income tax purposes. The regulation references unearned interest charges as part of the calculation for a bad debt claim using the pro rata method because unearned interest charges are specifically excluded from the "net contract balance" when using the pro rata method. (Regulation 1642, Appendix 1.) The issue of unearned interest does not arise when the contract method is used. However, many claims for refund on bad debt losses include amounts for "earned" interest although that is contrary to the regulation. Claimants contend that in some cases, the accounts have remained on an active collection status for several years, thus the interest is "earned" and therefore included by inference in the measure of the bad debt loss being claimed.
Merely because the regulation specifically excludes "unearned finance charges" from the pro rata method, it does not follow that "earned finance charges" must be deductible. Lenders are not entitled to claim refunds of interest (referred to as finance charges in the regulation), earned or not, on bad debts. The regulation specifically provides that whenever a bad debt deduction is claimed, the loss is limited to amounts on which the retailer paid tax. Only the gross receipts or sales price is subject to tax; interest is not subject to tax. (Regulation 1642(b)(1) and (f)(1).) Lenders have no greater right than the retailers from whom they purchased the contracts to claim bad debt deductions. (Regulation 1642(i)(5)(C).) 1/9/03. (2003–3).