Bad debts arise when customers who buy on credit fail to pay the debt and this triggers the trader to claim a deduction against their income for Income Tax purposes. The debt that is allowable as a deduction is that debt which the trader proves to be irrecoverable.
There are instances where traders claim a bad debt which does not qualify as a bad debt as required under the Income Tax Act. It is important that traders understand the conditions to be considered in deciding whether or not it is indeed a bad debt.
Conditions to be met before a debt is declared a bad debt for Income Tax purposes:
The debt must be proved to the satisfaction of the Commissioner General of ZIMRA to be irrecoverable:
- It must be due and payable to the taxpayer
- The debt must have been included in the taxpayer’s taxable income in the current year or in any previous year of assessment
- It must also be clear from the circumstances that there is no possibility of its recovery
As a taxpayer it is your responsibility to prove that a debt is bad. The following information, although not conclusive and exhaustive, may be submitted to support a bad debt claim as deduction:
- Name of the debtor and the amount of the debt
- Date when the debt was established
- Nature of debt
- The reason(s) it was considered to have become bad during the period covered by the financial statements
- The year of assessment in which the debt was included in the taxpayer’s income
- Any correspondence to the debtor including 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
- Judgment entered against the delinquent debtor
Issues to take note when dealing with bad debts include the following:
- A bad debt claim based on a percentage of the taxpayer’s total debtors is not allowable for Income Tax purposes
- The taxpayer should have exhausted all appropriate measures to recover the debt, without success, and should prove that the amount is irrecoverable
- 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 the taxable income in the year of recovery
- If a business is sold, including book debts, the seller may not claim any allowances for deduction, as the debts are no longer due to him/her
- 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 to seek professional advice and help in any area that you are not clear or do not understand in terms of income tax. There are penalties that the Commissioner General of Zimra will charge for understating the tax payable because of improper deduction of debts.