Updated: Jun 30
By: Patience Awadzi (Associate Tax Consultant, MTC)
For most organizations, the issue of bad debt is a bad news so they spend less time considering the VAT implications of the bad debt. The focus of this article is to look at the bad debt impact on standard rate scheme operators.
The general procedure is that, in order to claim the Output VAT on sales that has gone “bad”, the VAT should have been paid to the GRA by the seller at the point of sale and the debt written off from the books of the business.
What Constitutes Bad debt
Bad debt is simply a debt that cannot be recovered. It occurs when sales are made to customers on credit but for some reasons the customer is unable to pay for the goods or services supplied.
Businesses that operate ¨cash and carry¨ are less likely to record bad debt but for those who sell on credit, the probability of a customer not paying for goods or services supplied exist. Whiles sale on credit is inevitable because customers prefer to do business with those who provide flexible payment terms, an entity can incur huge sums of VAT that has been paid to the GRA but the amount was not received from the customer.
Occasionally, when VAT has been paid to GRA but the customers fail to pay, it may result in bad debt. This often creates huge VAT implication for businesses.
VAT and Credit Sales.
VAT is a consumption tax and businesses are mainly the appointing agents through which the VAT is collected and paid to the government. The VAT law has an established mechanism for businesses to account for the VAT collected. The most popular method is the standard rate invoice-credit mechanism where the amount payable as VAT by entities is the VAT collected on sales (Output VAT) less allowable deduction on purchases (Input VAT).
The system or mechanism for accounting for VAT is such that immediately sale takes place, VAT must be paid to the GRA within 30 days. Thus the rules are designed to ensure timely payment of VAT without waiting for the buyer to pay for the goods or services supplied, especially when payment terms are given. Payment of VAT charged to GRA, ahead of the expected receipt of the cash amount from customers is a normal aspect of VAT administration throughout the world.
When there is credit sale and the customer has not paid for the VAT, yet the VAT law requires that, the amount of VAT charged should be paid within 30 days, this will create cash flow problems. The business must therefore look for money elsewhere to pay for the VAT. Critics argue that, this aspect of VAT seems unfair since the business is just an agent for collecting VAT on behalf of government and if money must be borrowed at a cost to pay for VAT when there is credit sales, the business ends up incurring additional cost. On the other hand when there is cash sales the entity gets to use the tax paid for it operation for at least one month for free before paying the VAT to the government.
Credit sales being an inevitable part of business comes with its own VAT implications since the seller is required to pay the output VAT to the GRA and the buyer on the other hand also claims the same amount as input VAT from the GRA, when then buyer has not necessarily paid for the goods or services in question.
Where the buyer fails to pay the whole or part of the invoice amount (including the VAT charged), the seller may write off the debt as bad. This will result in a loss in sales revenue. But the real implications of bad debts on a firm is not only a loss in sales revenue, but a further loss in Output VAT already paid to the government.
Value Added Tax 2013, Act (870) and its Provisions on Bad Debts
Since the output VAT has been paid by the seller in anticipation that the customer will eventually pay for the goods supplied, the GRA must refund the output VAT paid because the customer was unable to pay for the invoices. However the rules are not as straight forward. Even when the seller loses revenue in addition to the VAT paid to GRA, logically, the equivalent of the tax paid to GRA should be refunded without any conditions attached, after all the seller is just an agent who collects the VAT on behalf of GRA and should not be made to suffer twice. However, the VAT rules are very specific with regards to this issue. The VAT law provides allowances for the equivalent VAT paid in a limited circumstance.
The rules regarding bad debt and VAT depends on two major pillars.
i) Whether the buyer is a taxable person or not and
ii) Whether the seller is entitled to input VAT credit.
Due to the above conditions in the law, bad debt really presents a different problem when payment is not received from the customer.
Section 46 of Value Added Tax 2013, Act (870)-Adjustment on account of bad debts.
46 of the Value Added Tax 2013, Act (870) provides as follows:
1. Where a taxable person issues a tax invoice for the supply of taxable goods or services and the supply was not received by the taxable person, the taxable person may deduct input tax under section 48 for tax paid in respect of the taxable supply that is subsequently treated as a bad debt.
2. Subject to subsection (5), the amount of deduction allowed under subsection (1), is the amount of the tax paid in respect of the taxable supply which corresponds to the amount of the debt treated as bad debt.
3. The deduction under subsection (2)
a. becomes due on the date on which the bad debt was written off in the accounts of the taxable person; and
b. Is available only if the taxable person satisfies the Commissioner- General that reasonable efforts have been made to recover the amounts due and payable.
4. Where an amount in respect of which a deduction has been allowed in accordance with Subsection (2) is at any time wholly or partly recovered by a taxable person, the taxable person is regarded as having charged tax in respect of taxable supply made during the tax recovered, with the amount of tax calculated according to the following formula: (A * B)/C where, (a) A is the amount allowed as a deduction under subsection (2);
(b) B is the amount of the bad debt recovered; and
(c) C is the amount of the bad debt previously written off.
5. A deduction is allowed under subsection (2) only if
a. The taxable supply was made to a person other than a taxable person; or
b. The taxable supply was made to a taxable person and the person claiming the deduction under subsection (2) issued a tax credit note to the taxable purchaser listing the amount claimed under subsection (2).
Implications of the Tax Laws
Section 46 makes provision for allowance in the form of input VAT but under strict conditions.
1. The equivalent of the bad debt which represents the VAT is refunded in the form of INPUT VAT under section 48 of the VAT Act.
2. This refund is only granted when the bad debt is written off in the books of the seller.
3. The Commissioner General must be satisfied that some efforts were taken to collect the mount. Section 46(3)(b) provides that the refund in the form of input VAT is available only if there are evidence submitted to the satisfaction of the Commissioner General that reasonable effort have been made to recover the amount but to no avail. The requirement of the Commissioner General being satisfied present a much bigger burden on the seller. Additional rules are provided under Regulations 50 of the Value Added Tax Regulations, 2016 (L.I 2243). Regulations 50 provides that, a debt shall be considered irrecoverable where a taxable person satisfies the Commissioner-General of the following:
a) The taxable person must have undertaken action for recovery of the debt;
b) The action for the recovery has exhaustively proven futile; and
c) The taxable person has made all the necessary entries in the books of account.
4. When the bad debt is recovered, the VAT must be recharged and accounted for in the month when the bad debt was recovered.
5. Finally the most important condition is provide for in Section 46(5).
The refund in the form of input VAT is allowed only if two conditions are satisfied:
a. The sale was made to e.g, an individual (non-taxable person).
b. The sale was made to a taxable person (registered VAT entity purchaser) and the seller had issued a tax credit note to the purchaser listing the amount claimed as input VAT
The general practice is that, most companies do not take into consideration the VAT implications when debts are declared bad and written off. Bad debt is a loss of revenue and further loss in output VAT when the necessary steps are not taken to recover the VAT paid to the GRA. Most businesses do not pay any attention to the further loss in output VAT hence basing the decision to write of bad debts on the mere loss of sales revenue.
It is recommended that, accountants and tax experts take steps to recover VAT paid on bad debts especially when the amount written off is huge. Bad debt write off decisions should consider the VAT implications.
The Writer is an Associate Consultant at MTC