C Limited v The Board of Inland Revenue – Doubtful Debts are Deductible

Are doubtful debts (as distinct from bad debts) deductible for tax purposes?

For the first time in Trinidad and Tobago (and in the Commonwealth Caribbean), the Tax Appeal Board of Trinidad and Tobago permitted a taxpayer to claim a tax deduction for a provision made in respect of “doubtful” debts.  In lay terms, a provision for doubtful debts is a taxpayer’s estimate as to the quantum of debts (receivables) it is unlikely to receive in any given year.  This is distinguishable from a bad debt, which is a debt that has been written off by the taxpayer as uncollectible (usually following the taxpayer’s unsuccessful attempts to collect the same from the debtor).

Facts & Argument

The subject matter of the appeal was the taxpayer’s corporation tax return in which a claim was made for both bad and doubtful debts pursuant to section 11(1)(c) of the Income Tax Act. The Board of Inland Revenue allowed the claim for bad debts, but disallowed the claim for doubtful debts on the basis that:

(a) The calculation is a general provision and is not specific to any particular debtor;
(b) The debts that became bad during the year of audit were specifically written off as bad in the Profit and Loss Account.

Legal Issues 

(a) Does the Income Tax Act have a regime for doubtful debts deductions as distinct from bad debts?
(b) What is the meaning of “general” and “specific” provision?
(c) What does ‘respectively estimated’ mean?

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Analysis

The Appeal Board confirmed that (i) Section 11(1)(c) of the Income Tax Act creates a regime for the deductibility of doubtful debts separate and distinct from the deductibility of bad debts and (ii) that it is a trite principle of tax law that a general provision for doubtful debts is not deductible for taxation purposes. The Appeal Board found that for a claim for deduction for a provision of doubtful debts to succeed it must relate to specific debtors.


For the first time in T&T (and in the Commonwealth Caribbean), the Appeal Board permitted a  taxpayer to claim a tax deduction for a provision made in respect of doubtful debts.


Concerning the meaning of “doubtful”, the Appeal Board adopted the partially subjective and partially objective test referred to in J.K. Limited v The Board of Inland Revenue (1967-77), 1 T.T.T.C. 399 at p. 402 to the effect that:

“It… must be based on the bona fide opinion [held by the taxpayer] as to the … doubtfulness of the debt made on an objective view of the facts as they appear at the relevant time . . .”  [Text in parenthesis added for clarity by the author]

Once certain accounts have been specifically identified as “doubtful”, the Appeal Board adopted the following guidance from Canada Customs and Revenue Agency (“CCRA”) Interpretation Bulletin I442R as being instructive in ascertaining whether the ‘provision’ had been ‘respectively estimated’:

Once having identified which debts are doubtful, the maximum amount of the reserve [i.e. provision] should be calculated based on an estimate as to what percentage of the doubtful debts will probably not be collected. This calculation should preferably be based on the taxpayer’s past history of bad debts, the experience in the industry if that information is available, general and local economic conditions, costs of collection, etc. This procedure may result in a reserve [i.e. provision] being calculated as a percentage of the total amount of the doubtful debts or a series of percentages relating to an age-analysis of those debts.  [Note: text in parenthesis added by authors herein for clarity only]

Although the Appeal Board did not expressly equate a “respective estimate” with a test of “reasonable estimate”, this is implicit in its reasoning.

The Appeal Board also looked at the ratio of the provision as compared to the entire Accounts Receivable in order to analyze its reasonableness.


This case has significant implications for any company, which in the course of business, extends  credit terms to its customers (e.g. financial institutions or companies that sell products on hire purchase terms).


Summary 

In order for a provision for doubtful debts to be deductible, the following characteristics ought to be present:

(a) The provision must generate from individual debtor accounts that have been specifically identified by the taxpayer as exhibiting characteristics of questionable collectability. This is both a subjective and objective process. It is subjective in that the taxpayer must hold a bona fide belief that the accounts are “questionable”, but objective in that the taxpayer must support their belief with rationale grounds (e.g. such as the debtor’s late payments).

(b) “Respectively estimated” requires that the provision be “reasonable”. The Appeal Board will take into account the commercial experience of the taxpayer, but will also consider the overall ratio of doubtful debts provided for in relation to the total of accounts receivable, to ascertain whether it is in “reasonable limits”. On the facts of this case the Appeal Board considered that a doubtful debt provision that represented a percentage of 2% of accounts receivable to be within reasonable limits.

(c) The Appeal Board confirmed that where a doubtful account has been identified, it is not the entire doubtful account that needs to hit the provision, it is only the portion that is considered (respectively estimated) to be uncollectible.  For example, if Claude Debtor owes $100, the taxpayer may treat $10 as uncollectible and $90 as collectible.

(d) There must be no double accounting between the bad and doubtful debt claimed by the taxpayer.

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Implications

This case has significant implications for any company, which in the course of business, extends credit terms to its customers (e.g. financial institutions or companies that sell products on hire purchase terms). It demonstrates that in the appropriate circumstances a company may make a provision for questionable accounts, which is deductible for tax computation purposes, without having to wait until the debt is written off as bad or uncollectible.


CAVEAT


The views expressed in this article are the views of the authors only and shared for discussion and information purposes only; they are not intended to constitute legal advice. Readers are encouraged to consult with their professional advisors for advice concerning specific matters.