Factoring is a commercial transaction in which a trading company sells its receivables arising from invoices issued to customers to a third party in exchange for immediate payment.
The economic rationale behind the transaction is to free up the selling company’s working capital, which is tied up in receivables from unpaid invoices – typically invoices with a long agreed payment term.
Three parties are involved in factoring:
- a seller that sells goods or services on deferred payment terms, usually up to 120 days;
- a business – a purchaser of goods or services which is the payer in the transaction with the selling business;
- factor – a third party (bank, non-bank financial institution, company) which acts as an agent, undertaking to collect the receivable from the buyer company and to pay it to the seller company.
Factoring is a tool for managing short-term trade receivables. It optimises working capital requirements through the professional management and financing of receivables and provides protection against non-payment.
Usually, the factor pays the business immediately or within an agreed period – the seller – a portion of the nominal invoiced value of the receivables, assumes the risk of collecting the same and the risk of a claim for breach of the contract of sale by the seller. The factor retains a portion of the amount as remuneration for its services.
The factoring agreement is a remunerated, long-term contract. It provides for remuneration for the factor, which may include the usual commission for carrying out the transactions under the agreement, amounts to cover the costs of any credit facility used, risk insurance, the collection of trade receivables, the administrative and accounting management of trade receivables, and other costs. The remuneration may be agreed as a fixed sum or as a percentage of the transaction value.
There are various types of factoring, and the factor generally seeks to meet the needs of the selling company. Some of the advantages of factoring are:
- A source of funding that takes the form of an advance payment for a purchased asset (receivables) and does not increase credit exposure. This allows for the use of additional credit facilities.
- An unrestricted and more flexible form of financing compared to traditional loans – the source of the financing is trade receivables, which grow in line with rising sales.
- Continuous monitoring of buyers’ creditworthiness by the factor.
- Improvement in balance sheet indicators relating to indebtedness.
- Services provided by a professional debt collection team.
Factoring, as defined in point 11 of § 1 of the supplementary provisions of the Corporate Income Tax Act, is a transaction involving the transfer of one-off or recurring monetary receivables arising from the supply of goods or the provision of services, regardless of whether the person acquiring the receivables (the factor) assumes the risk of collecting those receivables in return for remuneration. The remuneration received by the factor for the services it has provided to the selling enterprise constitutes income for the factor and is taxable under the Corporate Income Tax Act.
Under Article 46(1)(3) of the VAT Act, a factoring transaction constitutes a taxable supply. The tax base is determined in accordance with Article 26(2) of the VAT Act — it includes everything constituting remuneration for the supply, but excludes the amount of interest representing the credit element of the transaction, to which Article 46(1)(1) of the VAT Act shall apply. The value of the receivable does not constitute consideration for the service and is not a separate supply subject to independent tax treatment.
