Johannesburg, 11 Jun 2019
Recent amendments to tax legislation in SA, combined with sweeping changes to the accounting reporting landscape brought about by significant new standards such as IFRS 9, have created complex and important implications for tax-paying entities.
IFRS 9 on Financial Instruments became effective for all entities reporting on full IFRS (international financial reporting standards) if their annual period began on or after 1 January 2018. Therefore, all of these entities which report on full IFRS are now at the point at which they must comply with the new standard. This standard has made dramatic changes to the reporting and measurement of the allowances for bad debts in that it has moved towards a predictive model from the previous reactive model.
Add to this the fact that the South African Revenue Service (SARS) has modified the s11 deductions for the allowance for doubtful debts, to introduce paragraphs for entities complying with IFRS 9, and you have a recipe for a major administration headache.
As if confusion in the interpretation and application of the new paragraphs was not enough, there are practical challenges, including the need to report your calculations in an auditable format.
IFRS 9’s expected credit loss (ECL) allowance is a predictive model that aspires to report to users of financial statements the value of the asset that the reporting entity actually expects to recover from debtors. It takes into account a variety of factors, including, inter alia, the historical performance of the debt portfolio and the effect that future changes in the economy may have.
The recent negative surprise in SA’s GDP growth is a stark reminder of the complexities of IFRS 9 in an economy such as ours.
However, if done correctly, IFRS 9 is capable of providing fair estimates of the value of the debtors’ portfolio held by the entity as it accounts for specific factors applicable to the entity and its operating sphere. At a glance, it appears that SARS is leveraging the changes to the IFRS in order to allow more accurate tax allowances for taxpayers, while cleverly minimising the administration burden on SARS by placing the onus of auditing the IFRS 9 calculations on the taxpayer’s external auditors.
For large-scale entities such as banks, however, this is anything but a simple exercise because of the sheer number of factors that would need to be taken into account in the computations. These may need adjustment for future predictions or scenario analysis while still reporting the current computation in a manner which can be used in both the financial reporting and the tax submissions of the entity. Custom software for the computations and reporting would likely be needed.
The ECL model is essentially based on three specific stages, which can be broken down as follows:
The alternative tax allowance was straightforward and based purely on the age of the debt rather than entity-specific risk or in-depth analysis, as required by IFRS 9. This allowance was 25% of debts older than 60 days but not older than 120 days, and 40% of debts older than 120 days.
There is an immediate difference between these two allowances as IFRS 9 requires the reporting entity to evaluate and provide for risk from the inception of the debt, which may result in the IFRS 9 allowance being more beneficial to the taxpayer.
The interpretations of the new paragraphs are summarised in the following table:
1 For example, the debtor is in liquidation and the expected recovery is 5 cents in the rand.
2 Depending on which stage the asset was in previously, you would reverse that stage for that asset before claiming the stage 3 allowance.
It must be noted that taxpayers may approach the commissioner to issue a directive that the percentage contemplated above be increased to a percentage not exceeding 85% for stages 1 and 2.
The new provision is reliant on the accuracy and efficiency of your IFRS 9 computations to provide an accurate allowance, which may or may not be more beneficial to you, depending on your specific risks and computations when considering stages 2 and 3. However, the stage 1 allowance will always be more beneficial than under prior legislation as there is always some element of risk, resulting in a provision (and therefore tax allowance) even where the debt is less than 60 days old.
There is therefore an administrative and legislative requirement to have systems that accurately account for the complexities of the IFRS 9 computation. In addition, there is a strong economic rationale for doing so because of the favourable stage 1 allowance under the new legislative regime.
This article is not tax advice, but rather an attempt to clarify the effect of the new paragraphs when read with an understanding of the principles of IFRS 9.
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