MANAGING TAX RISKS: Should you pay tax on bad debts?

Bad debt is, arguably, a common feature in credit sales transactions and banking business. You make a credit sale and send your customer an invoice with an expectation of receiving your payment within a month’s time.

But your customer for some reasons is unable to pay you. You make several attempts to remind and follow up. But twelve months pass by and your customer has not paid! What do you do? Suing is not always an option.

We also frequently hear an acronym NPLs in the financial sector. When a bank’s customer fails to honor his loan repayment commitment within the agreed time and frequency, the bank will treat such a loan as an NPL. NPL stands for ‘non-performing loan’.

With its increasing trend in most banks in Tanzania, NPLs have recently become topical even for the non-bankers. NPLs are essentially bad debts.

How taxpayers treat bad debts has been a recurring area of tax disputes between TRA and taxpayers. Naturally, taxpayers do not want to pay tax on income they never received. Whether it is income tax, VAT or other taxes. In principle, the tax laws reflect this sentiment, though cautiously.

That no tax should be payable on bad debts. But when is bad debt really a “bad debt” from TRA’s point of view? The tax laws currently give TRA discretionary powers. This leads to subjective decisions and hence tax disputes.

In 2015, the new VAT law (VAT Act, 2014) came up with some objective criteria to address the issue of bad debts. A taxpayer could have obtained VAT relief once a debt remains uncollected for more than twelve months.

But the subsequent regulations (VAT (General) Regulations, 2015) almost reversed this back to subjective criteria. So, as we speak, TRA needs to be “satisfied” that a taxpayer took “reasonable steps” to pursue the debt before a tax relief can be granted.

In my view, both “satisfaction” and “reasonability” are extremely subjective criteria.

Bad debts can be significant amounts to taxpayers and hence dangerous to allow subjective decisions.

A reasonable step to the taxpayer may not necessarily be a reasonable step to TRA. This creates uncertainties which do not help in creating a good business environment.

At best, subjective criteria tend to encourage unethical practices in tax administration.

Fortunately, the bill to the Finance Act, 2018 proposes to give the Minister of Finance powers to make income tax regulations.

Regulations that, among other things, will carter for “income tax deductions including losses, bad debts, and depreciation”.

Hopefully, the regulations will provide more objective criteria for making tax decisions on bad debt.

The Bank of Tanzania (BOT), as a regulator of banks, issued several objective criteria on NPLs.

The banks, I think, will be eagerly waiting to see how the said tax regulations on bad debts will align with BOT criteria on NPLs.

One more issue on bad debt regulations. The said regulations will only address deductions for income tax purposes. What about other taxes? Bad debts tend to affect more than one tax type. Probably, regulations under the Tax Administration Act, Cap 438 could be more effective.