When a vendor, which is registered for value added tax (VAT) on the invoice basis, has made a taxable supply on credit, the vendor is generally required to account for the VAT on the value of the supply when a tax invoice for the supply is issued. If the vendor is unable to recover the debt, then s22(1) of the Value Added Tax Act, No 89 of 1991 (VAT Act) provides relief to the vendor by allowing for a deduction of the VAT previously accounted for, when the debt is written off as irrecoverable.
It often happens that the vendor then sells these book debts that have been written off to specialised debt collectors in an attempt to recover at least a portion of the losses suffered as a result of the non-payment by the debtors. The question that often arises is whether there are any consequences for the vendor regarding the sale of such book debts.
The book debts are generally sold to a debt collector on a non-recourse basis for amounts which are substantially less than the amounts owing. Proviso (iv)(aa) to s22(1) of the VAT Act, prohibits the claiming of a deduction for VAT on the transfer of accounts receivable at face value on a non-recourse basis. According to the Explanatory Memorandum to the Taxation Laws Amendment Bill, 1997 (Explanatory Memorandum), the purpose of proviso (iv) to s22(1) was to prohibit a deduction of the difference between the face value and the consideration for accounts receivable upon transfer thereof. This is because such discount is not considered to be an irrecoverable debt as contemplated by s22(1), but a financing cost.
The Explanatory Memorandum stipulates further that the ‘face value’ of a debt transferred is, for the purpose of s22(1), the net value of the account receivable at time of transfer, after adjustments have been made for debit and credit notes and after bad debts are already written off by the vendor. Therefore, if the special meaning to the term ‘face value’, as attributed by the Explanatory Memorandum is applied, then the accounts receivable, which have been written off as irrecoverable by the vendor, are transferred for a consideration greater than their face value, and not at a discount. Therefore, there is in any event no amount that could qualify as a deduction in these circumstances.
Accordingly, proviso (iv)(aa) to s22(1) of the VAT Act, does not preclude a vendor from claiming a deduction in terms of s22(1) on irrecoverable debts which are subsequently sold to a debt collector on a non-recourse basis, and no adjustment in relation to deductions previously made is required when the debts are sold.
A further aspect to consider is whether the vendor ‘recovers’ an amount, as contemplated by s22(2) of the VAT Act, when the book debts are sold.
Section 22(2) provides that where an amount, which was previously written off as irrecoverable in terms of s22(1) and any amount is subsequently recovered, the vendor is required to account for VAT on the amount recovered.
The debtors are never absolved from their obligation to make payment to the supplying vendor, and the total amount owing remains payable. The vendor disposes of its rights and interest in and to the debt owing by the debtors to the debt collector.
Section 12(a) of the VAT Act exempts from VAT the supply of ‘financial services’. The term ‘financial services’ includes the transfer of ownership of a debt security. A ‘debt security’ is in turn defined to include an interest in, or right to be paid money that is owing by any person. The book debts therefore comprise ‘debt securities’ and the sale by a vendor of such book debts is then exempt from VAT.
Consequently, when the vendor sells the book debts to the debt collector, the sale proceeds are consideration for an exempt supply, being the transfer of ownership of a debt security, and do not comprise amounts ‘recovered’ in relation to the book debts. The debt collector further does not make any payment to the vendor on behalf of the debtors when the book debts are acquired. The vendor merely transfers its right to recover the amounts owing by the debtors to the debt collector, who then becomes entitled to recover the amounts from the debtors concerned.
Accordingly, when a vendor disposes of book debts that have previously been written off as irrecoverable on a non-recourse basis to a debt collector, the sale is exempt from VAT, and the vendor is not required to make any adjustment in respect of the VAT previously deducted when the debts were written off as irrecoverable. The vendor is also not required to account for VAT on the sale proceeds.