Factoring (Tax) Law and Legal Definition

Factoring is a financial transaction whereby an enterprise sells its debt-claims to a third party in order to obtain cash (although less than the full amount of the debt). The third party then assumes responsibility for the administration and collection of the debt on the due date for its own account.

It is a short-term, non-bank financing of accounts-receivable. It is of four main types:

(1) In maturity factoring (also called service factoring), the factor maintains the seller's sales ledger, controls credit, follows up on the payments, and pays the amount (after deducting a commission) of each invoice as it falls due, whether or not the payment was collected.

(2) In finance factoring, the factor (called the financing factor) advances funds to a producer or a manufacturing firm, on the security of produce or goods that will be produced or manufactured utilizing those funds.

(3) In discount factoring (also called service plus finance factoring) the factor advances a percentage (usually between 70 to 85 percent of the value of accounts receivable) to the seller on a non-recourse basis and assumes the full responsibility of collecting the debts.

(4) In undisclosed factoring, a factor buys the goods from a primary party (producer, manufacturer, or seller) and then appoints the same party as its agent to resell those goods and to collect the payments. This arrangement prevents the disclosure that goods are being sold under a factoring agreement. The undisclosed factor, as in all other types of factoring, remains liable for uncollectible payments.

Factoring is a type of off balance sheet financing.