Will the 2021 budget speech signal a policy shift in relation to bad and doubtful debts?
We saw a significant policy shift in 2018 when the unfettered discretion of SARS to grant a doubtful debts allowance was eliminated, a process that involved a year-long interaction between SARS, National Treasury, taxpayers, and the standing parliamentary committee. This interaction culminated in a new version of section 11(j) which was strongly influenced by new accounting principles, in particular IFRS 9.
The treatment of bad debts however did not receive consideration and thus it remains governed by the courts’ few interpretations of the words of section 11(a) and (i) in this context.
Mindful of the interrelationship between section 11(j) and the section 11(i) and (a) treatment of irrecoverable debts, ENSafrica and others lobbied for a proviso to section 11(j) which would cater for the controversial treatment of bad debts which have been outsourced for post write off attempts at recovery. SARS released a draft interpretation note in 2020 which stated flatly that such debts would not (yet) be regarded as bad if handed over for collection to EDC’s. The proviso to section 11(j) would serve as a partial safety net, allowing such debts regarded by SARS as not yet bad, to qualify for a doubtful debts allowance, capped at 85%.
The draft interpretation note did not specifically distinguish between “covered” (essentially bank) lenders and other (non-bank) taxpayers although these two categories of taxpayers fall under two different doubtful debts regimes.
Some difficulties have become apparent. The safety net in terms of the proviso refers only to debts that have been written off for both income tax and accounting purposes. To the extent that taxpayers have effectively kept all or part of the bad debts on balance sheet, they do not qualify for the safety net at all if the tax write off is disallowed. At best, they might qualify for the capped doubtful debts allowance, provided that an appropriately crafted section 11(j) directive had been obtained. Even if a directive has been obtained, it might fall short of mitigating the cost where the maximum 85% allowance is inadequate in lieu of 100% bad debt deduction. Many taxpayers have recovery rates on their bad debts that are less than 15% of the gross write off, and they are of course prejudiced by paying tax on amounts that will never be recovered until the time comes to obtain a full section 11(i) or (a) write off.
This timing issue gives rise to a second challenge. A debt must be claimed as bad in the year in which it becomes irrecoverable. Sophisticated accounting standards and software models determine that the debt is bad in a particular year of assessment, which SARS apparently rejects as premature. Taxpayers who acquiesce in the approach of the draft interpretation note are forfeiting a possible 100 % write for at best 85%. In addition, there may be more risk in deferring the write off than claiming it “prematurely” (as SARS alleges is the case in terms of its draft interpretation note). Leaving the claim to a later year might open the risk that it is disallowed as too late, and there is no remedy because the earlier, correct, year of assessment is now time-barred and cannot be reopened. This point of time determination is one of the difficult features of our current section 11(i) and (a). Taxpayers must make the determination in the correct tax year.
Caught between these two rocks, a taxpayer might conclude that it is preferable to claim the debt as bad for income tax at the same time that it is written off for accounting purposes, and run the risk that SARS might disagree. The courts would ultimately have to decide, if the law does not change to align the tax and accounting treatment.
Even taxpayers who are seeking and obtaining section 11(j) directives do not have certainty due to the non-alignment of tax and accounting.
All of this is unsatisfactory and certainty in tax treatment is clearly desirable. It begs the question of whether a change in legislation should be announced in this year’s budget speech to close the gap between the two regimes for doubtful and bad debts. This might involve adopting an accounting-based test for bad debts so that the same principles govern the continuum of a debtors book, or adopting a legal interpretation or test which is expressly reconcilable with the principles used in section 11(j).
All of this might be seen as a storm in a teacup, which simply involves a timing difference in the continuum of doubtful and bad debts. (As mentioned, some of the differences might prove to be permanent.) However, it may have significant risks and costs for taxpayers and potentially involves SARS in complex ongoing litigation. The uncertainty of the COVID-19 environment must surely also be an important factor in adding to the uncertainty of bad debt recovery and thus strengthening the argument that a taxpayer is best placed to decide when to write off a debt as irrecoverable, and for the interests of the fiscus to be protected by the recoupment provisions of the Income Tax Act, 1962 which will ensure that no rand of income subsequently collected avoids the legitimate portion of the tax collector.
All of these factors and many more support the case for a shift in policy in this year’s budget speech so that certainty and predictability can be achieved in the legislative framework.
Executive | Tax
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