Irrecoverable debts – A real loss with a dim light at the end of the tunnel…

Irrecoverable debts is a fact of life. At least the VAT element of irrecoverable debts should be recoverable from SARS; with the emphasis on should!

In this article we deal with VAT relief for irrecoverable debts.

Introduction

In the previous article dealing with bad debt relief available for income tax purposes, we indicated that allowance is made in the income tax act for relief for doubtful debts and actual bad debts written off. These rules do not apply to VAT. Adjustments for VAT may only be made once a debt has actually become irrecoverable.

In this article we’ll take a bird’s eye view of the principles applicable to VAT adjustments for irrecoverable debts.

When may a deduction be made?

As a general principle a VAT vendor that has made a standard-rated taxable supply, has accounted for VAT on the supply to SARS in a VAT return and has subsequently written off the debt, is entitled to reverse the output tax previously accounted for on the sale when the debt becomes irrecoverable.

As with all other compliance areas, the devil is always in the detail.

SARS will only allow a deduction if the VAT vendor can prove that output tax on the sale has been paid to SARS, that the debts have been written off in the books of the VAT vendor (or at least are fully provided for) and that the VAT vendor does not personally continue to pursue the recovery of the debt. This means that if all the blocks are ticked, the VAT vendor may claim the deduction notwithstanding that recovery of the debt is being pursued by a third party (e.g. a debt collector appointed by the VAT vendor).

In practice VAT vendors must furthermore be in a position to prove which line items on a tax invoices are being written off and the VAT relating to such supplies. In instances where a VAT vendor makes standard rated, zero-rated and exempt supplies, the accurate allocation of receipts from debtors to invoices is critical to prove a claim for VAT on irrecoverable debts. If proper records are not maintained, the VAT vendor making the claim will not be in a position to demonstrate which portion of which invoice is being written off, and hence, prove its claim to an irrecoverable debt deduction. Also note that where a debt is recovered subsequent to the date that the claim for irrecoverable debts has been allowed, the previous claim must be reversed in the tax period that the debt is recovered.

Other issues

Special rules apply where debts are sold to a third person or where debts acquired by a third person are written off by such person. Due to the intricacy of these rules we shall not deal with it in this article, safe to say that you should be aware that these rules exist.

Summary

The above is a high-level summary of the VAT rules relating to the claiming of VAT on irrecoverable debts. The lifeblood of a successful claim is to maintain accounting records diligently to ensure that the appropriate information is available to prove your claim.