VAT implications on waived or reduced debts and business rescue plans

vatBy Anton Kriel, Tax Partner Grant Thornton Cape

The VAT Input Claw Back

In the ordinary course of business, creditors often reduce or write-off bad and irrecoverable debts. For the creditors, the VAT treatment is simple. If output VAT on the written-off debts was accounted for, the creditor is entitled to claim the VAT portion of the written-off debt as input VAT. However, for the debtor the solution is not as simple, and it could give rise to additional liability. In fact, the debtor may just be trading one creditor for another and the another being SARS.

While vendors that account for VAT on an invoice basis can claim VAT incurred on expenses as input deduction (subject to specific restrictions), strict legislation determines the impact for the debtors when debts are reduced. A VAT vendor that claimed an input tax deduction in respect the reduced debt must account for output tax on the portion of the debt written-off.

Debtors do not only incur an output VAT liability in respect of the debt amounts that are reduced. If a debt, in respect of which an input deduction has claimed been is not paid in full within 12 months from the date it was incurred, the debtor may be required to make an output tax adjustment and pay the output VAT on the portion of the outstanding debt.

In respect of debt, that by a written agreement is payable in instalments after the tax period in which the input tax deduction is claimed, the 12-month period only starts running from the end of the month when each payment becomes payable in terms of the contract. The 12-month input claw-back provisions do not apply in respect of debts reduced or waived between companies that form part of a group of wholly owned companies.

Debts Reduced in terms of a Business Rescue Process

The Companies Act 71 of 2008 introduced the concept of Business Rescue. Business rescue centres on the concepts of creditors accepting a business plan that has to be adopted and implemented by the business. Inevitably, such plans also include a compromise by the creditors in respect of debts owed to them.

Any VAT input previously claimed by the business in respect of the debts that are compromised must be clawed back by the business in rescue. This gives rise to additional debts, which not only places more pressure on the rescue plan, but in some cases could even result in the failure of the rescue plan.

As the actual reduction (compromise) of the debt only occurs after the effective date of the business rescue, current tax legislation does not allow for the VAT liability arising from the claw back to be included in any tax debts owed to SARS, and subject to the compromise.

In the tax proposal documentation issued with the Budget Speech in February 2014, SARS indicated that it was contemplating amendments to legislation to provide relief from the hardship caused by the VAT claw back provisions and other potential taxation obligations that arise when a business rescue plan is implemented.

However, until legislation is changed, the status quo remains and businesses that apply for the protection of a business rescue process are faced with the additional tax debts. The best case scenario is not only that the legislation is amended very soon, but also that SARS will apply the amendments retrospectively, or at least provide for a mechanism to deal with the additional (and often unforeseen) tax liabilities that arose after the implementation of business rescue plans since the business rescue legislation was introduced.