Will overdue Covid tax debt cause more bankruptcies for Dutch Small and Medium Enterprises?

Introduction

The economic landscape during the COVID-19 pandemic in the Netherlands presented several tremendous challenges for entrepreneurs. The pandemic triggered a substantial drop in revenue for many Dutch businesses. Since closures were imposed during Covid for multiple activities (e.g. restaurants and airlines), the drastic decline in turnover made it more complicated to service the debt. Prioritizing immediate financial needs, such as payroll and overhead costs, took precedence over setting aside funds for tax obligations. Adapting to remote work arrangements and disruptions in operations made it difficult for companies to fulfil tax compliance requirements in a timely manner. Administrative challenges and delays in record-keeping and reporting compounded the problem. In response to economic challenges, some businesses in the Netherlands implemented cost-saving measures such as layoffs and reduced working hours. These actions not only affected income tax collections, but also required additional government support for affected employees. Since closures were imposed during Covid for multiple activities (e.g. restaurants and airlines), the drastic decline in turnover made it more complicated to service the debt.

Deferral options Covid tax debt

In the context of the COVID-19 pandemic, the Dutch government implemented an unprecedented set of measures in March 2020 aimed at preserving jobs and stabilizing the economy. Among these measures, a simplified process was introduced for companies affected by the pandemic to request a deferral of their tax payments[1]. When such a request was submitted to the Dutch Tax and Customs Administration, the collection of taxes was immediately suspended. This tax deferment applied to various types of taxes, including income tax, corporation tax, payroll tax, and value-added tax (VAT). Furthermore, any potential fines for delayed tax payments were waived, and companies were given additional time to provide supporting documentation. Additionally, the interest typically charged on overdue tax payments, which is normally set at 4% after the payment deadline has passed, was temporarily reduced to almost 0%. This interest rate adjustment applied universally to all outstanding tax debts and across all types of taxes subject to interest charges.

For entrepreneurs who have taken advantage of the special deferment of payment due to the Corona crisis, the following deadlines were identified:

• From April 1, 2022: all the new payment obligations must be met again. As of this date, no new tax deferments related to Corona support measures have been granted.
• From October 1, 2022: the tax debt accrued during the special deferral should be paid with the special deferment payment scheme. The special scheme can be used under certain conditions and allows to pay off the tax debt by paying fixed amount (including collection interests) from October 1, 2022 to October 1, 2027.[2]

Since some entrepreneurs might encounter challenges when it comes to settling their tax debt within the specified timeframe and manner, additional deferment options have been introduced. For example, 6 months payment pauses, quarterly payments and extension of the repayment period to 7 years were granted. To be eligible for these measures, entrepreneurs[3] must satisfy several conditions. For instance, they must have ensured the timely payment of tax assessments received after April 1^st, 2022, without any exceptions. As indicated by the Tax and Customs Administration (Belastingdienst), in case the conditions to use the special deferment payment scheme were not met (for example, in case of arrears with repayments), the tax debt should have been paid in one lump sum before August 29^th, 2023.[4]

Magnitude overdue Covid tax debt

Throughout the COVID-19 crisis, a grand total of 400,000 entrepreneurs availed themselves of the option to defer their tax payments, involving a total amount of 47.7 billion euros. Approximately a year ago, there was still an outstanding balance of 19.6 billion euros among roughly 266,000 entrepreneurs. They were granted a five-year period for repayment. As of August 2023, over 233,000 companies still had active payment arrangements with the Tax Authority related to their COVID-19-related debts. Currently, approximately 193,000 entrepreneurs are operating under a payment arrangement. Collectively, these debts amounted to 16 billion euros. In late August, the State Secretary had announced the intention to recover funds from 35,000 entrepreneurs.

Last September, the Tax Authority initiated the process of dispatching the first legal notices to 27,000 entrepreneurs who are obligated to settle their entire COVID-19-related tax debt in a lump-sum payment, and it's noteworthy that bailiffs may even visit businesses to facilitate this process.[5] This measure has been necessitated due to their substantial arrears. However, according to the letter, some of these entrepreneurs have taken action after the government reached out to 35,000 entrepreneurs. Specifically, 2,000 of them have made full debt repayments, another 2,000 have caught up with their arrears, and 4,000 have sought assistance in the form of a payment arrangement. The process of tax debt collection from the remaining 27,000 entrepreneurs commenced in September by dispatching the first legal notices. These primarily include small businesses, often carrying debts of less than 20,000 euros. Following reminders, legal writs have been issued, enabling the seizure of assets belonging to these entrepreneurs. In total, the outstanding debt of these 27,000 entrepreneurs amounts to 1 billion euros. Later this month, approximately 8,000 additional entrepreneurs will see their payment arrangements cancelled due to substantial arrears. In mid-November, around 30,000 entrepreneurs with outstanding debts received warning letters. If they fail to take action within two weeks, their payment arrangements will also be terminated and the Tax authority will start to collect their debt. [6]

Increased number of Dutch bankruptcies

During COVID-19 pandemic, only a small minority of businesses faced bankruptcy. This was mainly attributable to government assistance programs, such as the aforementioned tax deferrals, which provided a lifeline for struggling companies. While there has been a slight uptick in bankruptcy cases in recent months, the overall numbers remain relatively low compared to the pre-pandemic era. However, the reimplementation of stringent tax policies by the Tax Authorities may pose a threat to companies that have been experiencing long-standing financial difficulties, potentially resulting in closures or bankruptcies.[6]

According to “Centraal Bureau voor de Statistiek” (CBS), in November, accounting for court hearing days, there were 7 additional company bankruptcies compared to October, marking a 2 percent rise. As shown in Figure 1, this upward trend in bankruptcy filings has persisted for over a year, with approximately 56 percent more companies declaring bankruptcy in the first eleven months of 2023 compared to the same period in 2022.

The adjusted count of bankruptcies shows significant fluctuations, with frequent alternating decreases and increases. The highest number of declared bankruptcies, 911 in total, was recorded in May 2013. Subsequently, bankruptcies decreased until August 2017, and the trend remained relatively stable until mid-2020. Following that period, bankruptcies continued to decline, reaching an all-time low of 109 in August 2021. As shown in Figure 1, starting from May 2022 there has been a consistent pattern of higher bankruptcy numbers compared to the same month in the previous year. Although the variations are substantial, it cannot be determined with certainty if the increase in bankruptcies is directly related to the end of the tax support from government during Corona times.[7]

Tax debt restructuring arrangement

For entrepreneurs who are not able to pay their tax and other debts, it is possible to enter into a restructuring agreement. This means agreeing with all creditors that only part of the debts will be paid. Normally the condition is that the tax authority receives at least twice the percentage of payment offered to other creditors. Because of the Covid-19 crisis, more flexibility has been introduced by Tax authorities, settling for receiving at least the same percentage of payment. This flexible policy was actually due to expire on October 1, 2023, but will therefore be extended until April 1, 2024, so that it becomes more attractive for other creditors to cooperate in a restructuring agreement.[8][9]

The extension of this favourable tax debt restructuring arrangement is only good news for other creditors. That is, it reduces their credit losses in case the 27,000 entrepreneurs mentioned earlier will fail to opt for and subsequently adhere to a payment arrangement with the tax authority.

Conclusion

Although it is too early to draw reliable conclusions after the tax debt collection started last September, the amount of entrepreneurs with overdue Covid tax debt is a bad prospect for Dutch bankruptcy statistics. Even though there are currently 27,000 Dutch corporations that have received a letter of exhortation, more corporations are expected to receive one too in the last quarter of 2023. That is, the amount of exhortation letters sent might double if indeed the 8,000 corporations warned in October and 30,000 warned in November will not repay their tax arrears. The prospect of a growing number of corporations not performing on their tax debt could fuel a continued increase in bankruptcies we have seen since 2022. A corresponding increase in default rates in Dutch Small Medium Enterprises (SME) portolios, might in turn require a recalibration of the Probability of Default (PD) credit risk models. The willingness of the Dutch tax authority to prolong favorable terms of tax debt restructuring however, is good news for the target variable of Loss Given Default (LGD) models in SME portfolios. The fact that Covid tax debt due for the 27,000 corporations receiving a letter of exhortation is currently only EUR 1 billion, can be an indication that the exposure of Dutch banks to these corporations will also be limited. Nevertheless, the impact on overdue Covid tax debt on the SME portfolios of Dutch banks will depend on the financial well-being of the 193,000 corporations with an active payment arrangement. RiskQuest will follow closely whether more of these corporations will join the group of 27,000 corporations already non-performing on their tax arrears.

[1] https://www.government.nl/latest/news/2020/03/19/coronavirus-dutch-government-adopts-package-of-new-measures-designed-to-save-jobs-and-the-economy

[2] https://www.belastingdienst.nl/wps/wcm/connect/nl/coronavirus/content/bijzonder-uitstel-van-betaling-vanwege-coronacrisis-tot-1-februari-2022

[3] It refers to entrepreneurs, since it may concern not only legal entities of corporations but also self employed natural persons (Zelfstandige Zonder Personeel, ZZP)

[4] https://business.gov.nl/corona/repaying-corona-support/pay-off-your-tax-debt-with-a-payment-arrangement-with-the-tax-administration/

[5] https://nos.nl/nieuwsuur/artikel/2486734-steeds-meer-ondernemers-in-problemen-door-hoge-kosten-en-schulden-na-corona

[6] https://nos.nl/artikel/2494280-belastingdienst-vordert-coronaschuld-in-eerste-dwangbevelen-verstuurd

[7] https://www.cbs.nl/nl-nl/nieuws/2023/50/iets-meer-faillissementen-in-november

[8] https://www.rendement.nl/contact-belastingdienst/nieuws/fiscus-verlengt-coulance-bij-schuldakkoord-tot-in-2024.html

[9] https://www.belastingdienst.nl/wps/wcm/connect/bldcontentnl/berichten/nieuws/tot-1-april-2024-gaan-wij-soepel-om-met-voorwaarde-saneringsakkoord