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 accounting principles, in particular IFRS 9 which came into effect in 2019.
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).
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. The proviso to section 11(j) would serve as a partial safety net, allowing such debts regarded as not yet bad, to qualify for a doubtful debts allowance, capped at 85%. The interpretation note did not specifically distinguish between “covered” (essentially bank) lenders and other (non-bank) taxpayers.
Some foreseeable difficulties have arisen. The safety net refers only to debts that have been written off for 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. At best, they might qualify for the capped doubtful debts allowance, provided that an appropriately crafted directive had been sought. At worst, such debts would fall into a lacuna for which no tax relief existed. SARS no longer has the unfettered discretion to determine an allowance. Even if a directive has been obtained, it might fall short of mitigating the cost where 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 systems 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 for 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).
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.
Even taxpayers who are seeking and obtaining section 11(j) directives do not have certainty. They have an accounting and systems-based approach to the bad debt write off and are faced with a SARS policy which appears to diverge completely from the accounting and the science.
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 at least a legal test which is expressly reconcilable with the accounting. Another approach might be to withdraw or amend the draft interpretation note and expressly adopt an interpretation of current law to remove the disconnect.
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. 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 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.
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