Over the past few years, the South African Revenue Service ("SARS") appears to have created a new category of doubtful debts allowances which they have termed a "specific" doubtful debts allowance, as distinct from the "ordinary" doubtful debts allowance to which a taxpayer is entitled under section 11(j) of the Income Tax Act, 1962 (the "Act") in the ordinary course in respect of its doubtful debts.
The "specific" doubtful debts allowance category has been created by SARS for the purpose of replacing a taxpayer's bad debt deduction (claimed under section 11(i) or (a) of the Act) where SARS has taken the view that the pool of debtors in respect of which a taxpayer claimed such a bad debt deduction is not in fact bad, but merely doubtful. Regardless of effort expended by any taxpayer in the collection process prior to the writing-off of a debt as bad and the claiming of a section 11(i) or (a) deduction in respect thereof, if any recovery processes take place post write-off, SARS has expressed the view that as a matter of principle, the entire pool of debtors is tainted and as such merely doubtful. The percentage of the specific doubtful debts allowance granted by SARS in these circumstances is generally based on the inverse of the bad debt recovery rate. For example, if a taxpayer's bad debt recovery rate is 25%, then SARS would grant a specific doubtful debts allowance of 75% in lieu of the bad debt deduction.
Arguably, the SARS approach is contrary to the correct interpretation of section 11(i) which provides (with our emphasis) as follows:
"11. For the purpose of determining the taxable income derived by any person from carrying on any trade, there shall be allowed as deductions from the income of such person so derived -
(i) the amount of any debt due to the taxpayer which has during the year of assessment become bad, provided such amount is included in the current year of assessment or was included in previous years of assessment in the taxpayer's income..."
The words "bad' or "become" are not defined in the Act. They have also not been authoritatively interpreted by the South African courts, although the courts have held that the question of whether a debt is bad or not must be decided at the time when the bad debt is claimed and according to the then-existing circumstances of the debtor. It has been pointed out further by our courts that subsequent circumstances (which we would submit include a future recovery of all or part of the debt, or of some other debt which was written off at the same time) cannot influence the determination made for that year of assessment. The foreign jurisprudence tends towards taking an objective and commercial approach in determining whether a debt is bad and aligns such a decision to that of a reasonable and prudent businessman.
Accordingly, we submit that it is the effort expended in respect of the collection procedures that takes place prior to the decision to write off a debt as bad, which should be of fundamental importance when evaluating a taxpayer's bad debt deduction. In addition, if evidence shows that a substantial percentage of debts written-off by a taxpayer as bad are in fact never recovered, it seems illogical to contend that those debts were not bad when written -ff at year end, and to subject the entire pool of those debts to a mere doubtful debts allowance. This approach seems unrealistic and uncommercial, given the volume of creditors and the sophisticated analytical and statistical methods adopted by the large corporate taxpayers, which appear to be the SARS targets in respect of this methodology.
The 2018 Budget Speech
On 21 February 2018, the Minister of Finance delivered the 2018 Budget Speech and tax proposals, which included a proposal relating to "clarifying the tax treatment of doubtful debts". His proposal stated as follows:
"In 2015, the South African Revenue Service (SARS) Commissioner's discretion in administering the Income Tax Act was reviewed and amended in anticipation of the move to a self-assessment income tax system. In 2015, the Commissioner's discretion on a doubtful debts allowance under section 11(j) of the act was deleted with effect from a date to be announced. The intention of such a deletion was that, in future, the allowance would be claimed according to criteria set out in a public notice issued by the Commissioner. However, no criteria have been formulated for the claiming of the allowance. To provide certainty, it is proposed that the criteria for determining the allowance should instead be included in the Income Tax Act."
It is notable that no mention is made of the section 11(i) or 11(a) requirements which feed into the determination of which debts are "bad" and which are "doubtful". It is also worthwhile mentioning the considerable gap that has arisen between the debts assessed as "doubtful" for accounting and financial reporting, as opposed to those allowed as doubtful under section 11(j). It remains to be seen as to whether, and if so, how the "specific" doubtful debts allowance will feature and/or be catered for in terms of the amended legislative regime.
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