Every business owner’s dreaded scenario. You’ve done the work, the quality’s great, the product’s excellent, your workmanship exceeds expectations, but your client isn’t paying. You’ve exhausted every avenue for finding a way for the account to be paid and now you’re faced with writing off the debt. What are the tax implications for your business?
A definition of bad debt
Bad debts are tax-deductible if they’re included in your taxable income in any tax year if it’s due at the end of the year of assessment. A tax allowance is also allowed for specifically identified debts.
Our legislation provides for two applications in this regard – those not based on IFRS 9 Financial Instruments guidelines (therefore only the Income Tax Act) and those based on IFRS 9 Financial Instruments.
The second scenario is when you (the creditor) and the debtor agree to waive or cancel the debt, which SARS sees as a concession or compromise under the Income Tax Act. A concession or compromise is a debt benefit that carries income tax consequences.
When should you give up on non-payment?
Bad debt accrues when money due by a certain date isn’t paid. This could be as simple as your client forgetting to pay or, in a more serious case, if they’ve had to liquidate.
However, when debt reaches 90 days, it’s increasingly more difficult to collect. Therefore, it’s important to stay on top of your receivables.
Some companies that lose a large percentage of revenue to non-payment account for these losses in their budgets. But whichever way you look at it, it’s not good for your business because this lost income will need to be made up either by raising your prices or getting more sales.
So, be persistent when it comes to chasing debtors and don’t give up until you absolutely must. You’ll know when the time comes – usually when chasing the debt becomes more expensive than getting the payment, or when it’s clear you’ll never receive payment.
What’s the implication of non-payment when it comes to SARS?
Under South Africa’s income tax law, when an amount is included in your income (in the current or a prior year of assessment), you are entitled to claim a tax deduction for any debt due to the taxpayer that has become “bad” during the year of assessment.
However, our Income Tax Act doesn’t clearly define what’s considered “bad”. Rather, SARS requires that every appropriate step is taken to collect the debt, including exhausting both in-house and debt collection agency efforts, and that every reasonable avenue has been exhausted to be sure there’s no reasonable hope of collecting the debt.
If there’s even the remotest chance that the debt may eventually be recovered, SARS considers this to be “doubtful” rather than “bad debt”.
The 2019 amendment
In January 2019, significant amendments were made to the Income Tax Act regarding doubtful debt allowances.
Before the amendments, if a detailed list of doubtful debts could be provided, SARS generally gave an allowance of 25%.
Now, the doubtful debt allowance depends on whether IFRS 9 is applied to the debt by the taxpayer for financial reporting purposes.
How are impaired financial assets measured?
IFRS 9 Financial Instruments requires companies to measure impaired financial assets, which includes your trade receivables using an expected credit loss model.
On the day you raise an invoice, your business must account for what you expect to lose. As time passes, this estimate is then revised until the bill is paid. Your terms should be set out in your credit policy.
Here’s how deductions are calculated:
- 40% of the face value of doubtful debts that are 120 days past due are allowed as a deduction, and
- 25% of the face value of doubtful debts that are 60 days past due, excluding doubtful debts that are at least 120 days past due are allowed as a deduction.
Allowance in different years of assessment
When a debt is written off in a prior year of assessment, and the debt benefit occurs in a different year of assessment as the disposal, then the total debt benefit amount is calculated as follows:
- Recoveries that were previously calculated on the allowance asset’s disposal are recalculated as if the debt benefit was considered on the recovery of the debt.
- The recalculated recovery is compared to the original recovery that was calculated when writing off the debt. It’s taxed as a recovery.
- If the disposed debt results in any capital gain or loss then, in addition to the recovery, calculations relating to capital gains or losses are applied.
To apply these models, please consult with your accountant for advice, or call us to book a consultation.