What happens to the VAT that was paid over to SARS?
Vendors often provide goods or services to clients on credit. In the current economic climate, clients are more likely to acquire goods or services on credit and may thereafter be unable to settle these debts. Other factors, for example disputes, may also result in vendors being unable or unwilling to make payment of debts.
This results in the vendor having to write off this debt as ‘bad’ or irrecoverable. In this article we take a closer look at the VAT implications of bad debts.
The Value-Added Tax (VAT) Act 89 of 1991 generally requires a vendor to register and account for VAT on the invoice basis. This means that the vendor is required to account for output tax on the supply of goods or services in the tax period where the time of supply is deemed to take place.
The general ‘time of supply rule’ envisaged in Section 9(1), requires the vendor to account for output tax at the earlier of an invoice being issued or receipt of payment. In instances where goods or services are provided on credit, output tax will be accounted for in the tax period during which the invoice is issued.
Under these circumstances, the vendor is required to pay output tax to SARS before it receives the actual payment from the recipient.
In order to allow for instances where no payment is eventually received by the vendor for the supply, Section 22 makes provision for a reversal of output tax previously paid on a debt that becomes irrecoverable.
Section 22(1) provides that where a vendor
the vendor may make a deduction of that portion of the VAT charged in relation to that supply as bears to the full amount of such VAT the same ratio as the amount of consideration so written off as irrecoverable bears to the total consideration for the supply.
The amount calculated under Section 22(1) may be deducted as input tax in terms of Section 16(3)(a)(v). However, before this deduction can be made, there are certain requirements that must be met.
What does this mean?
In simple terms, a vendor is effectively a collecting agent of the tax for SARS. This was confirmed by the Constitutional Court in the case of Metcash Trading Ltd v Commissioner of SARS and Another [(CCT3/00)  ZACC 21; 2001 (1) SA 1109 (CC), 2001 (1) BCLR 1 (C)], where the Court referred to vendors as ‘involuntary’ tax-collectors.
The VAT Act therefore gives consideration to the fact that a vendor had to account for (collect and pay over) VAT to SARS on a taxable supply made by it, but may never receive the payment (cash) for such supply from the recipient.
However, in order to claim the input tax on bad debts, there are three requirements that must be met by the vendor:
The third requirement must be carefully considered before making a deduction, that is:
When is a debt considered as written off?
The VAT Act does not provide any guidance on when the consideration would be regarded as being written off as irrecoverable, but SARS has previously stated in its VAT 404 Guide for Vendors (2015 edition) that a debt is considered irrecoverable when:
This no longer appears in the latest version of the VAT 404 guide but is still applicable, as in our experience SARS still applies this approach. It is noted that the Inland Revenue, New Zealand adopts a similar approach, as it views ‘written off’ being when the debt is written off in the accounting and record-keeping systems maintained by the vendor.
Based on the above, it is important to ensure that an actual write-off of the debt has taken place. An input tax deduction will not be allowed based on a provision that has been raised—even if this is required in terms of the relevant accounting standards. No deduction is allowed for doubtful debts, as this is an accounting provision and not a debt written off.
The writing-off of a debt must be based on an objective test evidencing that there is no reasonable likelihood that the debt will be paid. Factors that can be taken into account include how long the debt is outstanding, efforts taken to collect the debt; and the debtor’s financial position.
All of the above will provide a vendor with sufficient evidence to support an input tax deduction in respect of irrecoverable debts. We therefore recommend that in support of this approach, a vendor has a formal policy setting out its write-off process.
Methodology for write-offs of ‘combined’ supplies
The complication that arises with applying the provisions of Section 22 is in instances where a debt comprises a mixture of standard rated, zero rated and/or exempt supplies. Section 22 unfortunately does not prescribe a methodology for allocation of the outstanding debt to different types of supplies, nor does it require the vendor to request approval for the vendor’s methodology from SARS. In our experience, SARS will also not issue any ruling prescribing a methodology to follow in this regard.
In light of this, and following the VAT principles of self-assessment, the vendor is required to determine the extent of the bad debt deduction itself.
The starting point in this determination would be to look at the contract between the parties—a precedent established by the Supreme Court of Appeal in the case of Commissioner for SARS v Respublica (Pty) Ltd [(CCT3/00)  ZACC 21; 2001 (1) SA 1109 (CC), 2001 (1) BCLR 1 (C)]. If the contract provides for the allocation of the payment, then this must be followed to allocate payments against the debt.
In the event where the contract does not specify the allocation, or there is no contract, the vendor will have to consider an appropriate method for the allocation of payments to ultimately determine which portion of the outstanding debt relates to the standard rated supply.
It would also be prudent for the vendor to have this clearly documented as part of its policy, to ensure that SARS can validate this should it seek to review the methodology.
Bad debts recovered
In order to ensure neutrality and that the fiscus receives any VAT that is due, where a vendor subsequently recovers any portion of the bad debt for which an input tax deduction was previously made, the vendor is required to account for output tax on the recovery.
Deemed supply—Section 22(3)
While Section 22 mostly provides relief for the vendors not receiving payment for its goods or services, it is important to note that it also contains specific requirements for the creditor. A vendor that deducted input tax and has not paid the full consideration within 12 months is required to make an adjustment of its output tax on the portion of the consideration that remains unpaid.
However, there are certain exceptions to the above, namely:
Where payment is subsequently made, a vendor will be entitled to an input tax deduction.
The impact and takeaway
The VAT treatment of irrecoverable debts can be complex, and it is important that a vendor ensures that it has considered all the requirements in Section 22 before making any deduction in respect of irrecoverable debts. Vendors must also ensure that they are able to substantiate their position of the write off of irrecoverable debts.
It is not always an easy task to determine when and what amount can or may be deducted in relation to irrecoverable debts. Vendors are therefore encouraged to obtain the necessary and suitable advice to ensure that these aspects are dealt with correctly.
WRITTEN BY: RODNEY GOVENDER, MATTHEW BESANKO, and RIAAN VAN DEVENTER
Rodney Govender and Matthew Besanko are partners at PwC. Riaan van Deventer is a senior manager at PwC.
This article is an extract from the original article of the same name that was published in the September 2022 issue of PwC’s Synopsis.
While every reasonable effort is taken to ensure the accuracy and soundness of the contents of this publication, neither writers of articles nor the publisher will bear any responsibility for the consequences of any actions based on information or recommendations contained herein. Our material is for informational purposes and should not be construed as financial advice.