While there is no doubt that the current crisis will lead to companies recognising new provisions, here is a reminder of what is and is not possible to do in this respect.
Firstly, it should be emphasised that provisions are subject to strict accounting and tax rules, which have not yet been changed in law despite the crisis, and that provisions are traditionally subject to significant checking by auditors.
Strict accounting and tax obligations
We know that the annual accounts need to present a true picture of the assets, financial position and earnings, forcing companies to recognise depreciation of assets or anticipate risks, even if there are only potential.
In tax law, a provision is only allowed if several cumulative conditions assessed at the close of the financial year are met: the provision must be intended to face a deductible loss or charge (1), clearly specified (2), which current events (3) make likely (4), provided that it has been effectively recognised in the accounts for the deductible financial year (5).
In general, the current crisis “in itself” is not an adequate justification for new provisions. Analysis is required on a provision-by-provision basis, with proof in each case that the deductibility conditions are fully met.
Provisions to cover a future operating loss
Based on orders signed by the end of the 2020 financial year, some companies will be able to forecast a decline in activity over the coming financial years. A provision for future operating loss could then be considered, since it is possible in certain very specific cases involving contracts whose performance is spread over several years.
It is important to remember, however, that from an accounting and tax perspective such a provision can only be recognised if it results from an obligation to a third party. Can we expect more flexibility in view of the current crisis? As a reminder, the Budget Minister at the time of the Gulf War crisis refused the deduction of provisions intended to anticipate a simple loss of earnings or possible decrease in revenue. No clarifications have yet been issued and we can only hope that the scale of the crisis expected following Covid-19 will lead to a different position being taken by the tax authorities or the adoption of a specific system of regulated provisions.
Provisions for bad debts linked to the economic crisis
An unpaid debt may either be definitively irrecoverable, in which case it is a deductible charge, or its recovery may be classified as uncertain, justifying the posting of a provision. It is to be expected that a large number of receivables could be considered uncertain at the end of the crisis, due to many customers’ failure or fragility.
However, the company needs to be careful not to create general provisions for bad debts for all customer receivables appearing in the accounts. This easy solution would make the move counter-productive, since the deduction of such provisions would be rejected. The rule therefore remains that provisions need to be justified for each individual receivable rather than by the economic context alone.
In the event of an audit, the company must in particular be able to demonstrate, firstly, that the recovery of each receivable is uncertain and, secondly, that the amount of the provision has been determined precisely for each one. We should add that the use of statistical calculations is allowed by consistent case law if that method is appropriate to the company's situation and specific data. This method should be used with great caution, however, to avoid submitting a general lump sum calculation which would then be rejected.
A provision would also be possible for a receivable due from a subsidiary. We would like to point out in this respect that the Montreuil administrative court recently ruled that this type of provision is particularly valid if the subsidiary's net position is negative, providing the company did not intend to carry out either a debt waiver or a capital increase, although those would have been alternative options (Montreuil administrative court, 30 October 2017, no. 1607367).
Provisions for depreciation of business goodwill
In principle, a company's goodwill is not depreciable since its usefulness is not time-limited. However, in the event that goodwill acquired by the company experiences a significant overall depreciation compared with its capitalisation value, a deductible provision for depreciation could be recognised in the event of reversible impairment of the value of the goodwill. At the end of the financial year, the company must then carry out an impairment test by comparing the net book value of the goodwill with its current value. That current value corresponds to whichever is higher out of the market value under normal market conditions and the value in use, i.e. the value of the future economic benefits expected from use of the goodwill. It is only if the current value is significantly lower than the net book value of the goodwill that the company can deduct a provision for depreciation, which may not exceed the book value of the goodwill. However, it is important to ensure that the figures used in the calculation are sufficiently compelling.
Finally, if the company wishes to distinguish between components of the goodwill in the company’s assets, for example a customer database or even a right to a lease, creating a provision for depreciation of those components is allowed, but again it will be necessary to justify the individual nature of the component in question and the reality of its depreciation.
Insight: impacts of the Covid-19 outbreak
Our law firm provides you with legal assistance to understand all Covid-19 (Coronavirus) impacts on your business. Discover our special Insight below.
Find more about our law firm:
Our law firm is a leading international business law firm. Its deep roots, unique positioning and highly recognised expertise enables it to deliver innovative, high value-added solutions in tax, business, corporate and labour law.