How reasonable is reasonable for bad debt deductibility: Case study of the solar industry
After a promising deal, the phone keeps ringing and follow ups yield nothing but excuses, leaving the business owner staring at an increasing list of unpaid debts, torn between chasing payments or focusing on more productive ventures. The tax obligation remains despite not receiving payments from customers due to the challenges in proving "reasonable steps" for deducting bad debts, particularly during TRA audits.
According to the Income Tax Act (ITA), 2004, a person must provide evidence that they have undertaken all reasonable steps to recover a debt and believe the debt is uncollectible before it can be written off as a bad debt for tax purposes. For financial institutions, this deduction is allowed only after the debt is deemed uncollectible under regulations issued by the Bank of Tanzania (BoT), all reasonable steps to pursue payment are taken and the institution reasonably believes the debt will not be satisfied.
The lack of tax definition of “reasonable steps”, results in varying interpretations between taxpayers and the TRA. For financial institutions, the TRA often demands evidence of legal proceedings, a position supported by the tax court rulings that suing defaulters satisfies the criteria for bad debt deduction This creates a regulatory mismatch between BoT regulations and the ITA 2004 whereby the former mandate writing off a debt after 365 days in the “loss-making” category and the latter demands evidence of reasonable steps, creating challenges for the banking sector in managing non-performing loans. It is important to appreciate that legal proceedings are not always practical or economical for every debt.
The TRA often applies a blanket one size fits all approach, treating non-financial sectors such as the solar industry similarly to financial institutions. The business model of most solar companies involves selling products to customers who are largely low income households in rural areas on credit, with the recovery of payments being their greatest business risk. If a customer fails to make payments or shows inability to settle the debt, the company classifies the debt as “portfolio at risk” and initiates several payment recovery measures.
Solar companies manage the portfolio at risk through debt recovery officers who make follow-ups to the defaulters through recorded phone conversations, text messages, emails and home visits. If these efforts are unsuccessful, external debt collection agencies are contracted and if they fail the debts are written off. From the sector’s perspective, the steps taken are reasonable as court proceedings are uneconomical given the nature of the clientele and the amounts involved. In this context, the debts written off should qualify for corporate income tax deductions.
In judging what constitutes reasonable steps, the TRA should be mindful of the underlying circumstance rather than demanding evidence like police reports or lawsuits for every bad debt written off. Pursuing legal actions for small debts is not economical as the costs often exceed the debt in question.
In the National Budget Speech 2024/25, the Minister of Finance promised to issue regulations for review, recognition and bad debts write off, aiming to address the challenges faced by taxpayers. To date these regulations have not yet been issued, and taxpayers continue to suffer from the TRA's blanket approach.
Perhaps the Minister would consider borrowing a leaf from our neighbour Kenya, where the legal position is that for a bad debt to be deductible for corporate tax purpose at least one of the recovery measures listed in the guidelines must be satisfied. One of the measures is, if proved that the costs for recovering the bad debts exceed the debt itself then the bad debt will be deductible. This approach was upheld in the case of M-Kopa Kenya Limited (a solar company) vs Commissioner of Legal Services and Board Coordination, which ruled that a deduction for bad debts is allowed when the recovery costs exceed the debts involved. Similarly, South Africa assesses reasonable steps based on the specific circumstances of the debt in question.
My hope is that the regulations are issued promptly and cover all sectors and not just the financial industry. Meanwhile, the TRA should adopt a more “reasonable” approach by considering the individual circumstances of the taxpayers. This would foster a business-friendly environment rather than applying a blanket one size fits all approach on something that is subjective.
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