Draft Documents for Public Comment: Draft Interpretation Note on doubtful debts and accompanying documents

Draft Documents for Public Comment: Draft Interpretation Note on doubtful debts and accompanying documents

• 18 February 2020
• Legislation
• SARS

Important:

Due date for public comment: 31 March 2020

Purpose

This Note provides guidance on calculating the section 11(j) doubtful debt allowance.

Background

Section 11(j) provides an allowance to taxpayers for debts that are due but are considered to be doubtful. Under the previous wording of section 11(j), this section applied to all taxpayers with the Commissioner having the discretion to determine the amount of the debt that was considered doubtful. In practice, SARS generally allowed 25% of a taxpayer’s listed doubtful debts as doubtful debt allowance. Taxpayers could apply to SARS for an increased doubtful debt allowance based on their specific facts and circumstances. Owing to the ongoing process to prepare for an income tax self-assessment system and IFRS 9 coming into effect, section 11(jA) was introduced and section 11(j) was subsequently amended. Under the amended section 11(j), the calculation of the allowance that taxpayers (excluding those taxpayers to which section 11(jA) applies) may claim in respect of doubtful debts depends on whether the taxpayer applies IFRS 9 to the debt for financial reporting purposes or whether IFRS are not applied to the debt for financial reporting purposes.

The proviso to section 11(j)(i) and (ii) gives the Commissioner the discretion to approve an increase to some of the percentages specified in section 11(j) that are used in calculating the doubtful debt allowance to a percentage not exceeding 85%.

A detailed discussion of the workings of IFRS 9 exceeds the scope of this document. It is, however, necessary to provide some discussion and context as IFRS 9 is referenced in section 11(j)(i) for purposes of determining the doubtful debt allowance for a taxpayer that applies IFRS 9 to the debt for financial reporting purposes.

Before the introduction of IFRS 9, doubtful debt provisioning for financial reporting purposes was based on IAS 39. IAS 39 models relied on past observations with the further requirement of estimating future recoveries. Following the global collapse of financial institutions, the International Accounting Standards Board set out to correct the perceived weakness of delayed recognition of credit losses on loans and other financial instruments. The International Accounting Standards Board introduced IFRS 9 replacing IAS 39. While IAS 39 was based on an incurred loss model, IFRS 9 introduced a forward-looking “expected loss” model, which includes the incorporation of forward-looking information in the recognition of impairments on debts considered doubtful.

IFRS terminology

Section 11(j)(i) contains certain terminology derived directly from IFRS. The legislation accordingly cannot be understood in isolation from IFRS. For this reason some of the pertinent IFRS terminology is discussed below. 

Expected credit loss

An ECL is the probability-weighted result of the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive (that is, all cash shortfalls) discounted at the original effective interest rate.

Lifetime expected credit loss

An LECL is the expected credit loss that results from all possible default events over the expected life of the debt. This is the expected present value of losses that may arise when borrowers default on their obligation to make a repayment at some time over the life of the debt.

Loss allowance

The loss allowance is the provision for expected credit losses.

Impairment

A debt is considered credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that debt have occurred. These are referred to as default events. Evidence that a borrower is experiencing financial difficulty or that a debt is credit-impaired includes, but is not limited to, a breach of contract in terms of repayment, the probability of the borrower entering bankruptcy or other observable data relating to the recovery of the debt. It is not always possible to identify a single discrete event for impairment and it may be necessary to take the combined effect of several events into account.

IFRS 9 recognises various stages at which the ECLs must be recognised. The stage depends on the level of risk at the inception of the debt compared with the current level of risk associated with the repayment of the debt. Debts generally move through the various stages where there is a significant increase in the level of credit risk as evidenced through missed payments or other observable factors. In other words, the higher the risk of non- or late payment, the higher the stage of impairment. A debt is generally considered as being in default once it reaches stage 3. This stage involves the highest level of risk of non- or late payment of the debt.

The stage of default also determines how interest revenue is accounted for in the financial statements.

Different entities regard the point at which a debt is in default differently. IFRS 9 requires an entity to apply a definition of default that is consistent with how it is defined for its normal credit risk management practices, consistently from one period to another. It therefore follows that an entity might have to use different default definitions for different types of debt. IFRS 9 also requires that an entity needs to consider qualitative factors in addition to quantitative factors.

The different stages are described below.

This article first appeared on sars.gov.za

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