The tax implications of loan claims write-offs by Servicers in the context of settlement - The long-awaited regulatory intervention

Legal Insight

January 2025

(republished from taxheaven.gr)

George Psarakis, LL.M. (mult.), PgCert

Abstract: This article analyzes the new law 5162/2024 that regulates the tax treatment of debt write-offs. Specifically, from 1/1/2024, debt write-offs toward credit institutions and servicers in the context of out-of-court settlements are exempt from income tax. The exemption also covers older contracts under certain conditions, while maintaining the obligation to pay a Digital Transaction Fee of 2.40% on the final settlement amount.

According to Article 62(1) of Law 4389/2016, as amended by Law 4646/2019: "The benefit of a legal entity, legal person, or natural person who earns income from business activity, which arises from the write-off of part or all of the debt to a credit or financial institution, to a credit or financial institution under special liquidation, or to a company under Law 4354/2015 (A' 176) in the context of an out-of-court settlement or in execution of a court decision, is not considered a donation and is exempt from income tax."

According to paragraph 2 of the same article: "For debt write-offs under paragraph 1 in the context of out-of-court settlement, paragraph 1 applies exclusively to debts that were in arrears, disputed, or regulated on December 31, 2018, or fall within the scope of Law 4469/2017 (A' 62), and for out-of-court settlement agreements concluded from January 1, 2016, until December 31, 2020, or concluded under Law 4469/2017."

The grammatical formulation of the above provision suggests that the two conditions are distinct, meaning that it is sufficient either for the debt to be in arrears, disputed, or regulated on December 31, 2018, or (even if the above condition does not apply) for the settlement to be concluded by December 31, 2020. Under this interpretation, it would be sufficient for the debt to be in arrears on 31.12.2018 for the write-off amount not to be taxed as income. However, the interpretation of this provision had been the subject of intense disagreement, without any court decision or competent administrative body having resolved this issue to date. The problem existed because many supported the need for cumulative fulfillment of both conditions, i.e., in any case, a settlement should have taken place by 31.12.2020. Therefore, under this version, all settlements concluded from 1.1.2021 result in the taxation of the write-off amount for the benefiting debtor.

Given the above data, the safest and tax-neutral option for the debtor was for loan debt write-offs to go through either the out-of-court debt settlement mechanism or rehabilitation tools, where there are explicit exemption provisions (in Article 170 of Law 4738/2020). Additionally, other solutions had been proposed in this direction, such as the agreement to convert the debt into an imperfect obligation where it remains in the companies' books (and therefore no write-off takes place to be taxed) but is not judicially enforceable (in the "imperfect obligation" the element of compulsion and enforcement is missing).

And while this was the situation, a few weeks ago Law 5162/2024 was published in the Government Gazette, where Article 99 provided the following: "The benefit of a business arising from a creditor business's waiver of debt collection in the context of a mutual agreement or judicial settlement, which takes place in the context of their professional cooperation, constitutes income from business activity subject to the specific provisions of Article 62 of Law 4389/2016. In this case, the provisions on gift taxation of the Code of Inheritance, Donations, Parental Provisions, Dowries, and Gambling Profits Tax, which was ratified by the first article of Law 2961/2001 (A' 266), do not apply. By way of derogation from the first paragraph, the benefit arising from the write-off of part or all of the debt to a credit or financial institution, to a credit or financial institution under special liquidation, or to a company under Law 4354/2015 (A' 176) in the context of out-of-court settlement or from agreements concluded under Law 4469/2017 (A' 62) or in the context of the out-of-court mechanism of Law 4738/2020 (A' 207) or in execution of a court decision, is exempt from income tax."

The explanatory memorandum of the law states:

"This regulation reintroduces an exemption provision that applied to debt write-offs while concerning income tax due from 1.1.2024 onwards. The aim is to support legal or natural persons engaged in business activity who found themselves in a difficult position due to loan obligations they could not service and which became overdue, disputed, regulated, or subject to the out-of-court mechanism. Therefore, if it became possible to write off part or all of their debt to a credit institution or similar organization, in the context of an out-of-court settlement agreement, the exemption from income tax in the tax year when the write-off actually takes place is expected to help their return to a healthy business course and future profit realization."

Therefore, after the enactment of the new law, we observe the following:

Write-offs that have taken or will take place after 1/1/2024 in the context of out-of-court settlements with Servicers are exempt from income tax, which would otherwise burden the debtor.

The vast majority of settlement agreements concluded with Servicers include a write-off clause ("debt forgiveness") at the end of the settlement period, subject to the condition that there will be no violation of its terms and that the debtor will remain current. Therefore, even for older settlement agreements (before 1/1/2024) that have not yet expired, this provision will ultimately lead to exemption at the time the write-off takes place (provided, of course, that the law is not repealed/amended, etc.).

Settlement agreements are subject to a Digital Transaction Fee of 2.40% (if the creditor is a capital company) on the agreed amount, with the debtor of the settled claim being the subject and liable for its payment. Therefore, the amount resulting after the settlement and agreed to be paid in installments or lump sum will be used as the basis on which the Digital Transaction Fee will be calculated. Moreover, as was accepted under the Stamp Duty Code, the fee is due even if the legal relationship (act) from which the claim proposed for settlement originates is exempt from stamp duties by special provision of law or has previously been subject to stamp duties, because the settlement is its own independent and autonomous contract. Therefore, while we exempted the debtor from income tax, we maintained their burden with the Digital Transaction Fee. Of course, now the fee is calculated on the amount resulting after the settlement and not on the higher initial amount before the settlement, as was the case with the older Stamp Duty Law.