VAT Provisions with respect to irrecoverable debts

The sale of debts on a non-recourse basis can be a useful cash management tool. Have you considered how recent amendments to section 22 of the Value-Added Tax Act No. 89 of 1991 will impact your corporate tax compliance?

1. Introduction

Section 22(1) of the Value-Added Tax Act No. 89 of 1991 (“VAT Act”), allows a vendor to claim an input tax credit on a debt that has become irrecoverable. The input tax credit is equal to the amount of the irrecoverable debt, multiplied by the tax fraction.

Example

If 40% of a debt of R984 400 has become irrecoverable, the vendor would be entitled to claim an input tax credit of R51 360 (R984 400 x 40% x 15/115).

A vendor is only entitled to claim the input tax credit where the underlying supply was a taxable supply, and the associated output tax has already been accounted for in a VAT 201.

If the vendor is subsequently able to recover the entire or part of the debt, the vendor would then be required to account for output tax on the recovered amount.

2. Sale of debt

It sometimes happens that a vendor sells a debt to a debt collector or bank (“the seller”). The VAT consequences would depend on whether or not the debt is sold on a recourse or non-recourse basis.

It should be noted that the transfer of a debt constitutes financial services and would therefore be an exempt supply in terms of section 12(a) of the VAT Act. The seller would therefore not be required to impose any output tax when the debt is sold.

2.1. Sale of a debt on a recourse basis

Where a debt is sold on a recourse basis, the seller is not required to make any input tax adjustments when the debt is sold. The seller only becomes entitled to claim a section 22(1) input tax credit, where the debt is returned to the seller and written off as irrecoverable. The acquiring vendor (“the buyer”) does not become entitled to any input tax credits in terms of section 22(1) when the debt becomes irrecoverable.

2.2. Sale of a debt on a non-recourse basis

Neither section 22(1), nor section 17 of the VAT Act allows the seller to claim an input tax credit for any factoring costs incurred in respect of a debt sold on a non-recourse basis. Factoring costs represent the difference between the consideration and the face value of the debt. The seller is also not required to make any input tax adjustments when the debt is sold.

However, section 22(1A) of the VAT Act allows the buyer to claim an input tax credit where any amount of the face value of the acquired debt becomes irrecoverable. The input tax credit is limited to the amount paid by the buyer for the acquisition of the debt from the seller.

Of late, the Legislator noted that these provisions are being abused by vendors as follows:

The seller writes off the debt and then claims a section 22(1) input tax credit.
The seller then sells the written-off debt on a non-recourse basis and is not required to impose any output tax.
The buyer then claims an input tax credit in terms of section 22(1) if the acquired debt becomes irrecoverable. The credit is based on the face value of the acquired debt, limited to the amount paid by the buyer.

Effectively, this could result in a double input tax credit being claimed. To combat this abuse, the Taxation Laws Amendment Act No. 23 (2018) has introduced section 22(4) of the VAT Act to include the following definition of “face value”:

”face value” means the amount of the account receivable at the time of transfer less the amount written off by the seller, after adjustments have been made for debit and credit notes and amounts already written off as irrecoverable by the vendor.”

This amendment is effective from 1 April 2019. The effect of this amendment is that the buyer is no longer able to claim any input tax credit with respect to an acquired debt that has already been fully written off by the seller. This is because the new definition results in the face value of the debt being reduced to Rnil.

if you need assistance with assessing the impact of any tax amendments on your corporate tax compliance.