As you probably know, timing is everything in tax. So how do you know whether you should claim a doubtful debt allowance or a bad debt deduction?
Most businesses render services or sell products to their customers on credit. With this, there is an inherent risk that those debts may not be paid due to multiple reasons including a change in economic conditions affecting said customer.
As South African taxpayers, the revenue from the sale forms part of the taxable income in the year that it is sold whether the sale was on credit or for cash. However, if the taxpayer holding a receivable believes the debt will not be settled or there are reasonable grounds to suggest the debt may not be repaid at all tax adjustments can be made to accommodate this.
An example of such an adjustment is the section 11(j) doubtful debt allowance which is available to taxpayers with qualifying debtors and depending on whether the taxpayer adheres to IFRS 9 or does not apply it, the qualifying debtors may qualify for either the 40% impairment allowance, the 25% or a combination of these. The taxpayers may also apply for an increased impairment allowance, up to a maximum of 85% of the debt if certain requirements are met.
It is important to note that not all debt may be allowed as an allowance, e.g., short-term debt that is repayable on demand, and debt repayable in instalments that has experienced two full and consecutive missed payments may not qualify for the section 11(j) allowance. Furthermore, for debt to qualify for this allowance, it must have been included in the income of the taxpayer as the allowance is to accommodate the tax treatment versus the economic realities of the taxpayer.
The doubtful debt allowance is then reversed in the tax computation of the taxpayer in the next year and the current year’s doubtful debts are claimed instead. So there you have it, the doubtful debt allowance is appropriate where there is reasonable doubt that the debt will be repaid. Now, onto the bad debt deduction:
Taxpayers may also write off qualifying debt that is considered bad, instead of just doubtful in terms of section 11(i). This deduction is a once-off deduction of amounts previously included in the taxable income of the taxpayer and is only available once the taxpayer has ceased all efforts to recover the debt, which means debt ceded to another person may not be claimed under section 11(i) as that debt remains in the hands of the other person (the acquirer of the debt).
In SA, when a supplier makes a taxable supply and issues an invoice to the purchaser, VAT is included in the consideration and paid over to SARS at the point of sale (timing is dependent on the vendor’s registration basis). Where the supplier cannot recover the amount due from the purchaser (e.g., the debt is written off under section 11(i)) the supplier may claim a credit for the VAT previously accounted for and paid to SARS on the unpaid invoice.
It is important to note that no VAT adjustment is required to the original VAT treatment when a doubtful debt allowance is claimed. However, when the debt is written off, a credit may be claimed from SARS, provided all requirements are met, one of which is the ceasing of further actions to recover the debt.
Now, back to the original question: How do you know whether to claim the doubtful debt allowance and when do you claim a bad debt deduction? The answer is it depends, which of the above requirements are applicable to your outstanding debt and what your expectations are for the settlement of this debt.
It may be more sensible to first claim the doubtful debt allowance first and since that allowance claimed will be reversed, it can be reviewed at the end of each tax year for probability of repayment if it is still outstanding. Where the taxpayer then considers the debt non-repayable and has ceased all efforts to recover the debt, the bad debts write-off would be more appropriate.
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