Texas Comptroller of Public Accounts    STAR System


200708432L



AP 113

Date: August 17, 2007
To: All Audit Staff
From: David Rock, Audit HQ
Subject: Bad Debts Related to Private Label Credit Agreements

Prior to October 1999, only retailers who extended credit to a purchaser on an 
account that was later determined to be a bad debt were entitled to a credit or 
refund of tax paid on the bad debt. The retailer must have been the entity 
making the sale, entered the sale as a bad debt on its books, and claimed it as 
a deduction for federal income tax purposes.

Effective October 1, 1999, Section 151.426(c) was added to allow anyone who 
extends credit to a purchaser under a retailer’s private label credit agreement 
to claim credit or refund of bad debts.  Note that Section 151.426 only applies 
to limited sales tax; it does not apply to other tax types.

For anyone who is not familiar with what a private label credit agreement is, 
here’s an example: 

Mr./Ms. Texas Consumer applies for a credit card offered by XYZ Retailer and is 
approved.   Mr./Ms. Texas Consumer makes a purchase and charges it the XYZ 
Retailer credit card.  XYZ Retailer recognizes the sale and reports on its 
Texas sales tax return the sales tax associated with the credit card purchase.  
Mr./Ms. Texas Consumer make credit card payment to ABC Company (because it 
extends the credit behind XYZ Retailer’s credit card).  Mr./Ms. Texas Consumer 
later defaults on its credit card debt.  ABC Company recognizes the bad debt 
for federal income tax purposes.

Section 151.426(c) states: Subject to Subsection (e), a retailer or any person 
who extends credit to a purchaser under a retailer's private label credit 
agreement, or an assignee or affiliate of either, is entitled to credit or 
reimbursement for taxes paid on the portion of:

(1)  an account determined to be worthless and actually charged off for federal 
income tax purposes;  or

(2)  the remaining unpaid sales price of a taxable item when the item is 
repossessed under a conditional sales contract.

Go to 
http://tlo2.tlc.state.tx.us/statutes/docs/TX/content/htm/tx.002.00.000151.00.htm
 for Section151.426(e) and the entire text of Section 151.426.   More 
information about bad debts can be found in sales tax rule 3.302 at 
http://info.sos.state.tx.us/pls/pub/readtac$ext.ViewTAC?tac_view=5&ti=34&pt=1&ch
=3&sch=O&rl=Y. 

Here are some important facts to remember regarding bad debts related to 
private label credit agreements:

Who is entitled to claim a credit or refund per Section 151.426(c)?

* A permitted retailer who extends credit to a purchaser under their private 
label credit agreement.  This means that the retailer who extended the credit 
can take the bad debt credit through its sales tax returns or can file a refund 
claim for the bad debts.  In this situation, the entity that made the original 
sale, reported the sales tax and realized the bad debt are the same.

* Effective October 1, 1999, any person who extends credit to a purchaser under 
a permitted retailer’s private label credit agreement.  Example:  ABC Company 
extends credit to purchaser under XYZ Retailer’s credit card.  In this 
situation, the entity that made the original sale and reported the sales tax is 
NOT the entity that realized the bad debt.

* If the entity that extends the credit is permitted for sales tax, the bad 
debt credit can be taken as credit on its sales tax return or it can file a 
refund claim for the bad debts.

* If this entity chooses to file a refund claim, it must meet the requirements 
for a perfected refund claim per Section 111.104.

* Effective, October 1, 1999, an assignee or affiliate of the retailer or 
person who extends credit to a purchaser under a private label credit 
agreement.

* This scenario is usually the parent seeking refund of bad debts that were 
recognized by its subsidiary.  The subsidiary extended credit to the customer, 
and therefore must assign its right to refund to the parent, if the parent is 
to claim the bad debt refund. 

* If the entity who extends the credit assigns its rights with regard to the 
bad debts, the assignee MUST file a refund claim.  Even if the assignee is 
permitted for sales tax, it cannot claim the bad debts as credit on its sales 
tax return—it MUST file a refund claim.  See STARS document 200203888L.

* If it is discovered during audit fieldwork that a taxpayer has taken credit 
on its sales tax returns for assigned private label bad debts, the auditor 
should assess the credits taken in the audit.

* The assignee’s refund claim must meet the requirements of Section 111.104 and 
must include an Assignment of Right to Refund form.  Statute of limitations is 
not tolled until both a perfected refund claim is filed and the assignment is 
presented to the state.

* Statute of limitations is determined by the assignor’s statute---not the 
assignee’s.

Key points to remember:

* The bad debts MUST have ACTUALLY been charged off for federal income tax 
purposes per Section 151.426(c).  It is not sufficient that the bad debts have 
been written off in the credit extender’s books.  ALWAYS request the federal 
income tax return and reconcile the bad debt refund claim to the return where 
the bad debt deduction was taken.  This is the ONLY way to know if the correct 
entity has requested the refund and presented the correct forms and refund 
assignments.

* Refund or credit is limited to the taxable sales, which resulted in bad 
debts, made by the retailer with whom the credit extender entered into the 
credit agreement.  In many cases, XYZ Retailer will have third party retailers 
located in its stores who accept XYZ Retailer’s credit card in payment of sales 
it makes.  For example:  XYZ Retailer may have third party fast food stores, 
third party cell phone retailers, third party photography studios, third party 
beauty salons, etc., operating within its stores.  Only the bad debt sales made 
by XYZ retailer qualify for refund under Section 151.426(c).  The sales made by 
the third parties, even if charged to the XYZ Retailer’s credit card, do not 
qualify for refund.  ABC Company entered into agreement with XYZ Retailer, not 
the third party retailers operating within its stores.

* A growing trend is the conversion of retailer credit cards to retailer 
MasterCard or VisaCard.  (XYZ Retailer MasterCard).  These sales are treated as 
third party retailers described above.   Only the sales made by XYZ Retailer 
that resulted in bad debts would qualify for refund.
* Retailers may contract with third parties to operate departments within its 
stores.  Example, jewelry departments, shoe departments, etc.  If the retailer 
does not recognize the sale and report the sales tax on sales made by third 
party departments, any bad debts resulting from those sales are not subject to 
refund or credit under Section 151.426(c).

* Section 151.426(c) applies to a retailer’s private label credit agreements, 
not just private label credit card agreements.

* Bad debt refund claims, of any kind, do not earn credit interest.

* Reduce bad debt refund claims by any applicable filer discounts (timely filer 
or prepayment) taken by the retailer.

Records, information and documentation required but not limited to:

* Copy of agreement between retailer and entity extending credit to determine 
if it qualifies per Section 151.426(c).  If a refund claim is filed that 
includes multiple retailers, the private label credit agreement MUST be 
provided for EACH retailer.  If there is any question as to if an agreement 
qualifies Section 151.426(c), the auditor should employ current procedures to 
determine taxability as in any other situation.  The agreement should be 
examined by the auditor to determine the terms of the agreement.  The agreement 
provided MUST be signed by both the retailer and the entity extending the 
credit.

* The comptroller recognizes there is competition among financing companies and 
respects their right to protect confidential information.  However, this does 
not override the need for review of agreements with retailers.  Agreements that 
are so redacted that the terms of the agreements cannot be ascertained will not 
be accepted.

* Name and eleven digit Texas taxpayer number of each retailer included in the 
refund claim or for which credit was taken to determine if the retailer is/was 
permitted for sales tax.

* Information to reconcile bad debt refund claimed to bad debt write-offs per 
the federal income tax return (FIT).  If a consolidated FIT is filed, the bad 
debt write-off must be broken down by entities included in that consolidated 
return.  Then, for the entity in question, the write-off must be broken down by 
retailer.  Finally, for the retailer in question, a breakdown of write-off by 
state must be provided.

* Spreadsheets, in electronic format, that include EACH customer account 
written off for which refund is being claimed.  The spreadsheet should include 
but is not limited to the following information:  Customer name; customer 
account number; write-off date; billing city address; date customers made 
purchases; amount of purchases made; sales tax charged on purchases; finance, 
interest and late fees charged to the customer account; payments made by 
customer; amount written off; and any other charges made to the customer 
account---insurance, cash advances, purchases from third parties, etc.  This 
detail is required to determine the amount subject to sales tax refund vs. 
amount written off and to determine that payments were properly allocated to 
taxable and non-taxable account activity.

* This spreadsheet will be considered the population of customer accounts from 
which customer accounts of interest will be selected for a sample review.  
Sample will be conducted in accordance with state of Texas sampling guidelines.

* Homogenous retailers can be combined into a single population based on Texas 
sampling guidelines.  When determining if retailers are homogenous, type of 
products sold should be taken into consideration.  Example:  retailer selling 
only clothing would not be combined with a retailer that sold clothing, 
household goods, groceries and prescription drugs.  A retailer selling only 
clothing would not be combined with a retailer that sold building supplies to 
both commercial and individual customers.  The type of charges that can be made 
to an account should be taken into consideration as well.  Example:  insurance, 
cash advances, purchases from third parties.

* For the sample customer accounts selected, a complete customer account 
history must be provided from which the auditor will verify the taxable and 
non-taxable components of the write-off and determine the amount of write-off 
qualifying for refund.

* If the retailer offers different types of customer accounts, the type of 
account must be identifiable in the spreadsheets.  Example:  
commercial/business accounts vs. personal accounts.  It will be determined on a 
case by case basis if sample populations should be separated by type of 
customer account.

* Information must also be provided for recoveries made on accounts previously 
written off for which sales tax refund/credits were previously claimed.

Other things to consider:

* Private label bad debt refund claims can be a little more difficult because 
the auditor is verifying a refund being claimed by an entity other than the 
entity that made the sale and reported the tax.  It can be helpful to request 
sales tax histories and review prior audits and refunds on the retailers who 
made the sales that resulted in bad debts. 

* A walk-through of the retailer’s stores to determine if third parties are 
operating within a retailer’s stores, what products the retailer sells—taxable 
vs. non-taxable (food and prescription drug departments which would be 
non-taxable).

* A visit to the website of the various retailers included in a refund claim 
may reveal what type of non-taxable purchases can be charged to a consumers 
account or, again, if third party retailer purchases can be charged to an 
account.  For example, travel promotions, various types of insurance, and third 
party sales that do not qualify for refund are promoted on retailer websites.

* Visiting a retailer’s website can also be helpful in determining which legal 
entity extends the credit behind the private label agreement. 

* Retailers are still entitled to other bad debt refunds, such as bad debts 
resulting from bad checks.

If you have any questions regarding this memo, please contact the Area Manager 
of Technical Support, the supervisor of Technical Support, or the subject 
matter expert in Audit Headquarters. 

As STAR is the Comptroller's research system for Texas tax policy issues,
only tax-specific audit policy memos (AP Memo) are included here. AP memos
not on STAR can be found on Window on State Government on the
Audit Memos web page.




ACCESSION NUMBER: 200708432L
SUPERSEDED: N
DOCUMENT TYPE: L 
DATE: 08/17/2007
TAX TYPE: SALES