DEDUCTIBILITY OF BAD DEBTS

UNDERSTANDING THE TAX IMPLICATIONS AND BEST PRACTICES

OVERVIEW
▪ In accounting, bad debts refer to accounts receivable that are unlikely to be collected
by a business. When a customer or client fails to pay their outstanding debt, it becomes a
bad debt for the company. These uncollectible debts can arise due to various reasons, such
as financial difficulties, bankruptcy, disputes, or customers intentionally avoiding payment.
▪ Accounting for bad debts is important for maintaining accurate financial records and
reflecting the true value of accounts receivable. There are two primary methods for
accounting for bad debts:
• Direct Write-Off Method: Under this method, bad debts are directly written off as an expense
when it is determined that a specific customer's debt is uncollectible.
• Allowance Method (or Provision for Doubtful Debts): The allowance method takes a more
conservative approach by estimating and recognizing potential bad debts in advance.

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CIT DEDUCTIBILITY OF BAD DEBTS
▪ Section 18 of the Income Tax Act, 2004 (ITA 2004), provides that the provisions are notional
(yet incurred) expenses hence non-deductible in computing CIT.
▪ Provision for bad debts therefore is temporarily non-deductible.
▪ Section 25 and 39 of the ITA provide the conditions that the bad debts should meet to be
considered as a bad debt.
▪ The sections provides that for deduction of bad debt to be valid the person has to initially
write off the bad debts from the books of accounts and:
• For financial institution (FI), the bad debt has become bad as per BOT established standards
and that FI has taken reasonable steps in pursuing and it reasonably believes that the debt
claim will not be satisfied;
• in any other case, only after the person has taken all reasonable steps in pursuing payment
and the person reasonably believes that the entitlement or debt claim will not be satisfied.
PRACTICAL CHALLENGES
▪ Below are the practical challenges associated with deduction of the written off bad debts:
• The ITA 2004, has not defined the time period that qualifies for writing off of the bad debts.
This has paused a great deal of complications to taxpayers. For VAT purposes however, the
VAT Act, 2014 has been considerate and has determined the time frame of 18 months.
• Non-definition/ interpretation of the reasonability of efforts to be taken by taxpayers in
the ITA 2004. This brings a great room of interpretation especially for the TRA tax auditors
who normally disqualify the efforts made by taxpayers to recover the bad debts (hence
disallowing the written off amounts).
▪ These challenges create a certainty risk such that, despite the efforts made by a taxpayer in
following up the debts, the TRA may still consider the same as insufficient to allow the bad debts
in determination of taxable income.
TAXPAYERS ▪ Despite inconsistencies and practical challenges surrounding bad debts

EFFORTS deductibility, in event of tax audit, the taxpayer may ensure that there are
evidences supporting the efforts made. The evidences should at least
include:

• Demand Notices issued to customers

• Certificate of bankruptcy/insolvency for insolvent companies

• Court Cases

• Auctions of assets/customer security to recover the balances due

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