Why is a refund a bad idea?

The complaining client syndrome

Some time ago we wrote about the new (or not so) phenomenon of the refund extortion. Today we will examine the “refund” from another point of view. We will analyze the fiscal risks and the reputational damages that it can cause.

Taxes and refunds – really dangerous

Imagine the following situation. You (the seller) agree with the buyer to deliver goods or services and (obviously) to get paid for it. But after the deal is done and the goods or services are delivered, you decide to save some taxes. So you sit down with the buyer, and as you know each other already pretty well, you agree to formally cancel the deal. So you agree to officially refund the money to the buyer, who in turns pays you back in cash. You then issue the buyer a credit note and voila – taxes saved. You don’t have to pay 20% VAT, you don’t pay 10% tax on profit and you don’t pay 5% dividend tax. So with this little “trick” you can save yourself up to 35% from the selling price. This is especially “convenient” if you are providing services and your cost goes mainly for office, salaries, etc.

And if you think it’s hard to convince your buyer to go for this scheme, then think again. What if you offer to “share” the tax savings with him? We bet there will be many customers who will gladly accept your offer. Because sharing 35% off the price can lure many money-hungry customers.

The bad news is however that such arrangements are not only non-ethical. The thing is that the tax authorities know very well that such things are being done. So for every refund, especially for services, where it’s hard to show whether the service has been provided or not, the tax authorities will immediately deem the credit note as suspicious. And here is where your problems will begin.

Tax and criminal responsibility for the seller for unjustified refunds

So imagine a consultant (the seller) has invoiced 20 000 EUR to a client of his. Then after some time, the client decides that he is not happy from the services obtained and requests full refund. We will be not judging here whether the refund request has been legitimate or not. But you can be quite certain that the taxman will certainly deem this refund as “suspicious”, to put it mildly.

It is very probable that such refund will be not accepted as legitimate by the tax office and will be declared as non-compliant. This will result in immediate reversal of 10% of the tax results, so the consultant will need to pay 10% on the refunded amount, or 2 000 EUR. This is on top of eventual VAT that may be due. According to the Bulgarian penal code, non declaring taxes in excess of 3 000 BGN is punishable with jail sentence. And you guessed it right, 2 000 EUR is more than 3 000 BGN.

Corporate reputation and refunds

The other issue that one should consider before making a refund are the reputational consequences. Imagine that a well run company is doing great business and is considering expansion. Such expansion may be stock-exchange listing (IPO) or attracting private investors who will invest in the shares of the company. So far so good. In order to achieve its goals, the company takes care that its balance sheets are perfectly in order, the EBITDA is healthy and so on. But then the would be investors see that the company has refunded huge percentage of its revenue. What could that mean?

1. The company is evading taxes (see above);
2. The company is missing hugely on its profit potential and is refunding everyone who requests refund;
3. It is uncertain whether the business model of the company is sustainable, bearing in mind it has to refund so frequently;
4. The company is having serious issues with its predictability, as at any moment it may refund some (or all) of its profits.

No need to tell you that no serious investor will ever consider spending any money for such a company. And what if after investing in such enterprise, the refund requests spike through the roof?

Our advice before you consider refunding

We would recommend you to evaluate with great caution all pros and cons before making a refund. We believe that a refund is only due in very limited circumstances. Even if you are not a victim of refund extortion, making a refund can have catastrophic consequences (see tax liability above). The reputational damages are worth considering too.

We would advise you to, unless you are in serious breach of your obligation under the contract, to defend your rights in Court. Even if you lose the legal battle and are forced to make a refund, you will avoid all issues with the tax office and the reputation of your company. Your company will retain its reputation as a company that does everything to defend its legal rights.