A debt in relation to deductions allowable for income tax act purposes.

When is a bad debt allowable as a deduction for income tax purposes?

What is considered a bad debt to the taxpayer may not necessarily represent a bad debt in the eyes of the tax authorities, thereby posing some challenges when it comes to the determination of taxable income. There is therefore  need to understand the conditions that should exist if  these debts  are to be   allowed   as deductions for income tax purposes, in terms of Section 15 (2) (g) of the Income Tax Act (Chapter 23:06).

For a bad debt to qualify as an allowable expense for tax purposes, it must meet the following conditions:

• The debt should be due to the taxpayer
• It should be  proved  to be bad and to  the satisfaction of the Commissioner
• The debt must have been included in the taxpayer’s income in  the  current year  or any previous year of assessment
• It must be clear from the circumstances that there is no possibility of its recovery.

The taxpayer bears the burden of proof that a debt is bad and the following information although not conclusive and exhaustive, may be submitted to support a claim for this deduction:

• The name of the debtor and the amount of the debt
• The date the debt was incurred
• The nature of the debt
• The reason why it was considered to have become bad during the period covered by
• the accounts
• The year of assessment in which the debt was included in the client's income.
• Any correspondence to the debtor including any responses/or failure to respond on the part of the debtor, which may include, reminder notices issued, formal demand notices, service summons, and proof of any other debt collection efforts
• Judgement entered against the delinquent debtor
• It should be noted that a bad debt claim based on a percentage of the taxpayer’s total debtors is not allowable for income tax purposes.  In addition, the taxpayer should have exhausted all appropriate measures to recover the debt, without success and should prove that the amount is irrecoverable.
• It is also important to note that:
• Where a taxpayer recovers a debt which had previously been deemed a bad debt and allowed as a deduction for tax purposes, the taxpayer will be required to disclose this and include the whole amount recovered in taxable income in the year of recovery.
• If a taxpayer has sold his business, including book debts, he may not claim any allowances for deduction as the debts are no longer due to him.
• Where a client has waived his rights to a debt, he is no longer entitled to a claim for its treatment as an allowable deduction for tax purposes.

Debts purchased with a business and subsequently found to be bad are not allowable deductions as they would have never been included in the taxpayer’s income (for the new business owner).   The same principle applies to an inherited business and to a newly admitted partner in respect of partnership for debts incurred before such inheritance or his admittance as a partner.

It is important for our valued clients to understand these guidelines in order to avoid penalties that may be raised for understating income arising from improper deduction of debts that do not qualify as allowable deductions.