News of P2P lending Bulgaria. January was Klear record month ever, with 450 000 BGN of loans financed. This is a great start for 2019.

The second topic to share with you is about Klear friends from phyre. They have an awesome digital wallet that helps you save time and bank fees!
Part of the Bulgarian FinTech ecosystem, they are doing their best, like Klear, to bring great financial products.

So, when appears a new type of revenues like the one coming from investing in P2P loans, you can imagine how complex it is to find the proper way to treat this new stream. The current Bulgarian tax regulation does not yet explicitly considers this new asset. Therefore, after a deep analysis with the help of a tax Bulgarian consultant, Klear made their interpretation of how the tax base should be calculated and declared in Bulgaria.

Klear knows that this approach could be questioned. Klear opted for full transparency on the applied methodology because Klear believes that it is the very first step to ensure a constructive discussion on this topic.

The goal of this article is to explain the rationale and the formulas behind the calculations and to answer some of the most frequent questions Klear received about taxation.

Should Klear issue a tax collection notice as per the article 35 of the tax regulation?

No, this notice is issued only when the payer of the income is a company or a self-insured person and when the tax is deducted from the payment.

In the case of Klear platform, the payers of the income are the borrowers who took a loan with Klear and they are physical persons. Therefore, there is no such notice.

Should I declare the credits I have invested in as provided cash loans in my tax statement?

No, because the investment in the loans is done through an assignment agreement between you and Klear (transfer of the rights to receive the proceeds of the loans). Klear remains the lender.

Taxation of the incomes from interest

Before explaining the taxable income from interest, let’s review the different definitions Klear already has on the platform regarding the interest.

Received interest is the part of interest included in the monthly instalment paid by the borrower each month on his due date.
Earned interest is the interest you actually gained. It’s equal to the interest received on which, on one hand, you deduct by the purchased interest (accrued/overdue) and, on the other hand, you add the sold accrued/overdue interest and the accrued/overdue interest present in the outstanding of your portfolio.
The taxable interest is the earned interest on which you deduct the outstanding accrued & overdue interest of your portfolio. Although the outstanding accrued/overdue interest is something you earned, it is not yet taxable because it is not yet realized, i.e. you did not yet receive it.

Taxable interest = earned interest – outstanding accrued/overdue interest

Another way to calculate is the taxable interest is the following formula:

Taxable interest = received interest – purchased accrued/overdue interest + sold accrued/overdue interest

Why do we need to correct the received interest with the purchased and sold accrued/overdue interest?

When you buy a piece of credit, you pay to the seller the interest he earned but was not yet paid to him by the borrower. When you receive this amount from the borrower, you should not account it as a profit because you just paid for it. On the opposite side, when you sell a piece of a credit to another investor, he pays to you the accrued/overdue interest you earned so far. Therefore, you realize your profit and this amount becomes taxable.

What happens if you use the received interest?

Then the tax authorities will receive twice more than it should be because both you and the seller will pay tax on the sold/purchased accrued/overdue interest!

Should you declare the amount of outstanding accrued/overdue interest from your balance?

No. Although is earned, it is not yet realized. You will report it in the next tax declaration when you receive it (or sell it).

Taxation of capital gains/losses

Klear concluded that the calculation of gains or losses on capital should be done only when the piece purchased has been fully sold or when the credit is terminated whatever the reason. If none of these conditions is met, then the calculation of possible gain or loss will be performed in the following year(s), when one of these conditions is fulfilled.

This assumption has been taken because of the specificity of the investment in pieces of loans.

Klear considered various options but all of them hit a showstopper. One of them was to apply the methodology of average price (the usual approach in stocks) where Klear calculates, one each sale transaction, the difference between the sale price and the average purchase price of all the purchase transactions.

However, Klear faced the issue that the base of the asset (credit) is changing with the time passing because of the amortization of the credit. Each month, the borrower repays part of the principal borrowed, which means that the nominal is evolving. This constant evolution of the base of the asset would require a complex adaptation of the average price methodology and therefore we abandoned the investigation of this option.

Now let’s look at how we concretely calculate the capital gains/losses.

First, on each purchase transaction of a piece of credit, Klear calculates the difference between the nominal value (outstanding purchased at that time) and the price paid for this piece. And we sum all these differences.

Difference on purchases = (Nominal – Price) on purchased principal + (Nominal – Price) on purchased postponed interest + (Nominal – Price) on purchased accrued interest + (Nominal – Price) on purchased overdue interest

If you purchased some pieces on the secondary market with a discount, then this difference would be positive and is the capital gain.

Second, Klear makes a similar calculation with all the sales transactions, including the sales occurred on the defaulted loans.

Difference on sales = (Nominal – Price) on sold principal + (Nominal – Price) on sold postponed interest + (Nominal – Price) on sold accrued interest + (Nominal – Price) on sold overdue interest

This difference is the capital loss.

Therefore, the difference between these 2 values is what we call the capital gain/losses.

It’s important to highlight that for most of Klear investors, this difference is negative because of the losses coming from the defaulted loans sold at discount. This is logical as, in the P2P lending model, part of the interest received on the vast majority of performing loans is used to cover the losses from the few defaulted.

In the last part of the article, we present a few numerical examples to illustrate these formulas.

To conclude this chapter, it is important to highlight that Klear thought it is useful for everyone to understand the details of the calculation Klear provided to each investor. This is their interpretation and it cannot be taken as tax advice.

Each investor is responsible for the filling of his tax statement and can adopt a different interpretation.

Klear is at the disposal of their investors to answer questions and provide additional details if needed.

Numerical examples

Case A)
On 01.02.2018, I purchase a piece of credit A with an outstanding of 100, of which 98 principal and 2 accrued interest. No discount, I pay 100.

The credit is fully repaid before the end of the year and I receive in total 98 principal + 9 interest.

Taxable interest = 9 -2 =7

Capital gains/losses = none because there was no discounted purchase or sale

Case B)
On 01.02.2018, I purchase a piece of credit B with an outstanding of 100, of which 98 principal and 2 accrued interest. No discount, I pay 100.

I receive repayments of 40 principal and 5 interest till 01.7.2018. At this date, I sell the remaining outstanding of 59, of which 58 remaining principal and 1 of accrued interest. I sell it without a discount.

Taxable interest = 5 -2+1 =4

Capital gains/losses = none because there was no discounted purchase or sale.

Case C)
On 01.02.2018, I purchase a piece of credit C with an outstanding of 100, of which 98 principal and 2 accrued interest. No discount, I pay 100.

I receive repayments of 40 principal and 3 interest till 01.7.2018. At this date, I sell the remaining outstanding of 61, of which 58 remaining principal and 1 of accrued interest and 2 of overdue interest. I sell it at 30.

Taxable interest = 3 -2+ 1 +2 =4

Capital gains/losses = 0 -(61 – 30) = -31

Case D)
On 01.02.2018, I purchase a piece of credit D with an outstanding of 100, of which 98 principal and 2 accrued interest. No discount, I pay 100.

I receive repayments of 40 principal and 3 interest till 01.7.2018. At this date, I purchase another part of credit D, for an outstanding of 61, of which 58 principal, 1 of accrued interest and 2 of overdue interest. I pay only 20 for this piece.

The credit is then fully repaid, and I receive additionally from this date 116 of principal and 13 of interest.

Taxable interest = 3 -2 + 13 -1 – 2 = 11

Capital gains/losses = 61 – 20 = 41

Case E)
On 01.02.2018, I purchase a piece of credit E with an outstanding of 100, of which 98 principal and 2 accrued interest. No discount, I pay 100.

I receive repayments of 40 principal and 3 interest till 01.7.2018. At this date, I purchase another part of credit E, for an outstanding of 61, of which 58 principal, 1 of accrued interest and 2 of overdue interest. I pay only 20 for this piece.

Till the end of the year, I received repayments of 70 principal and 8 interest. There is a remaining outstanding at the end of the year.

Taxable interest: 3 – 2 +8 – 1 – 2 = 6

Capital gains/losses: none as the investment is not yet terminated at the end of the year

Case F)
On 01.02.2018, I purchase a piece of credit F with an outstanding of 200, of which 195 principal and 2 accrued interest and 3 overdue interest. I pay 180.

I receive repayments of 40 principal and 6 interest till 01.7.2018. At this date, I sell everything remaining, 155 principal and 1 accrued interest. I sell it at a nominal price, 156.

Taxable interest: 6 -2 -3 +1 = 2

Capital gains/losses: 200 -180 = 20

Case G)
On 01.02.2018, I purchase a piece of credit G with an outstanding of 200, of which 195 principal and 2 accrued interest and 3 overdue interest. I pay 180.

I receive repayments of 40 principal and 6 interest till 01.7.2018. At this date, I sell everything remaining, 155 principal and 1 accrued interest. I sell it at a nominal price, 156.

Then on 01.09.2018, I purchase another piece of this credit G with an outstanding of 400, of which 390 principal, 1 accrued interest and 9 overdue interest. I pay 150.

On this piece, I receive 180 principal and 17 interests. Remains 220 principal and 2 accrued interest at the end of the year.

Taxable interest: 6 -2 -3 +1 -1 – 9 + 17 = 9

Capital gains/losses: 200 -180 =20. The second investment is still active, therefore we cannot yet assess what is the realized capital gain/loss on this piece of credit.

Case H)
On 01.02.2018, I purchase a piece of credit H with an outstanding of 30, of which 20 principal and 10 overdue interest. I pay 15.

Till 01.07.2018 I received 5 of interest.

Then I sell the outstanding of 30, of which 20 principal, 1 of accrued interest and 9 of overdue interest, at a price of 15 BGN.

Taxable interest: 5 – 10 + 1 + 9 = 5

Capital gains/losses: (30 – 15) – (30 – 15) =0

Source: Klear