Termination of an Obligation by Debt Forgiveness

Termination of an Obligation by Debt Forgiveness

Article 598 of the Civil Code of Ukraine (CCU) provides the parties to a contractual relationship with the right to agree on the termination of obligations under a contract, including by way of debt forgiveness (Article 605 of the CCU). Pursuant to this provision, an obligation is terminated as a result of the creditor releasing (forgiving/cancelling) the debtor from its obligations, provided that such release does not infringe upon the rights of third parties with respect to the creditor’s property.

Accordingly, debt forgiveness terminates the performance obligations under a contract, provided that such forgiveness does not violate the rights of third parties concerning the creditor’s assets. In particular, at the time of entering into the debt forgiveness agreement, the creditor must not have assigned the relevant claim to a third party, and bankruptcy proceedings must not have been initiated against the creditor.

Taking into account subparagraph 14.1.257 of paragraph 14.1 of Article 14 of the Tax Code of Ukraine (TCU), any funds received by a taxpayer under an agreement that does not provide for the accrual of interest or any other form of compensation for the use of such funds and that are subject to mandatory repayment shall be considered repayable financial assistance.

For tax purposes, non-repayable financial assistance includes, among other things, funds transferred to a taxpayer under a gift agreement, similar agreements, or without entering into any such agreement.

Consequences of Termination of an Obligation by Debt Forgiveness

In a letter issued by the Main Department of the State Tax Service in the Dnipropetrovsk Region and published on 21 May 2025, it was stated that debt forgiveness of an accounts receivable debt is treated as non-repayable financial assistance. Accordingly, the debtor (recipient) must increase its pre-tax financial result in its accounting records by the amount of the forgiven debt.

Therefore, the debtor is required to recognize the forgiven debt as income and pay either corporate income tax or the single tax on such amount. The creditor forgiving the debt, in turn, recognizes the written-off accounts receivable as an expense in its accounting records, except where the debt is forgiven in favour of a related party or a non-payer of corporate income tax. In such cases, the creditor may be required to apply tax adjustments ("tax differences") that increase the taxable base in accordance with Article 140 of the TCU.

As regards VAT, the tax authorities maintain that where a debt is forgiven in relation to goods delivered or services rendered previously, the creditor’s accrued VAT liabilities are not subject to adjustment. Accordingly, a reduction of VAT through a corrective adjustment calculation is not possible because the goods have not been returned.

With respect to the debtor, having received an additional benefit in the form of debt forgiveness, the debtor is required to pay the relevant taxes to the state budget (Higher Administrative Court of Ukraine, Case No. K/800/5707/17 dated 6 September 2017).

Documentation of Debt Forgiveness

1. Debt forgiveness must be documented in the same form as the underlying agreement from which the obligation arose. Accordingly, the parties to the original agreement should enter into a separate agreement under which the creditor waives, in whole or in part, its right of claim, while the debtor acknowledges that its obligations under the original agreement are terminated and that corresponding tax liabilities arise, including corporate income tax on the amount of the forgiven debt.

2. The parties to the commercial obligation should conduct an inventory of accounts receivable and accounts payable and prepare a mutually signed Reconciliation Statement of Mutual Settlements.

3. For accounting purposes, an appropriate Order (Resolution) should be issued authorizing the write-off of the relevant accounts receivable or accounts payable.

In addition, we recommend that the parties execute an additional agreement terminating the underlying contract.

Apart from the principal obligations that are typically subject to debt forgiveness, a contract may also contain other obligations, including penalties for late delivery, late payment, delivery of defective goods, and similar breaches.

Forgiveness of a portion of the principal debt does not terminate the parties’ obligations with respect to such ancillary liabilities. Consequently, after executing a debt forgiveness agreement, the parties may face unexpected claims relating to obligations that were not expressly waived.

Therefore, the proper documentation of debt forgiveness transactions may affect not only tax liabilities but also potential losses arising in the course of business activities.

The specialists of Dmitrieva & Partners are ready to assist you in properly structuring and documenting all your business transactions.