Question

A taxpayer is a plumbing supplies store that offers credit terms to some of its customers . On 30 June , accounts receivables were $ 50,000 . Of this amount , $ 20,000 was doubtful debts . No bad debts were written off in the accounting records during the income year . The director has signed a written document prepared by the company accountant on 29 June . This document authorised writing off a debt of $ 15,000 , which is more than six months overdue . The company is also having trouble locating another client that owes $ 5,000 . Determine the available deduction for ' bad debts ' in the income year . Explain your answer with reference to the relevant provisions of the ITAA97 , any case law and any guidance provided by the ATO .

Answer 1

U/S 25-35 of ITAA 1997:

Available deduction for bad debts in the Income Year = NIL

Provisions U/S 25-35 0f ITAA 1997 Stipulates the following regarding treatment of Bad debts for Tax purposes:

25‑35 Bad debts

             (1) You can deduct a debt (or part of a debt) that you write off as bad in the income year if:

                     (a) it was included in your assessable income for the income year or for an earlier income year; or

                     (b) it is in respect of money that you lent in the ordinary course of your business of lending money.

By analysing these provisions, the Tax Payer needs to satisfy following conditions for claiming Bad Debts deduction in the Income Year:

1. The debt must exist. This condition is satisfied in the current case. TR92/18 - A debt is a sum of money due from one pperson to another. ATO accepts the existence of a debt if a busness is entitled to receive a sum of money either at law or in equity.
2. The debt must be bad. This condition is also satisfied in the current case although the debt becomes bad in the following year. When will be a debt be bad. the ruling in TR92/18 is relevant. It states that as long as the commercial judgement pointing to the relevant facts indicates that adebt is bad for the time being, the debt can be treated as Bad.
3. The debt must be written off as bad in the income year. This condition is NOT satisfied in the current case as the debt is not written off as bad in the income year. In the case of Point v. FCT, it was decided that no deduction will be allowed in a year, if the debt is written off after the year's end at the time when the books of accounts are being prepared.
4. The debt was included as assessable income in the current income or in an earlier year. It is assumed that the amount is included in the assessable income.

In the Case of $15,000, Condition 3 is not satisfied and ​​​​​​​ ​​​​​​​In the Case of $5,000, Conditions 2 & 3 are not satisfied. Doubtful debts can't be treated as bad debts. However, in the case of $5,000 where locating debtor is difficult for taking further action can also considerd as bad under the crcustances mentioned by TR92/18. So,.in both the cases no bad debts are deductible in the Income Year

Although, The Tax Payer can't claim for deduction of Bad Debts under 25-35 of ITAA 1997in the income year, he may look for claiming it under general deductions under 8-1 of ITAA 1997.

General deductions

             (1) You can deduct from your assessable income any loss or outgoing to the extent that:

                     (a) it is incurred in gaining or producing your assessable income; or

                     (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.

Things to Consider:

• The loss must not be capital nature
• The loss must not be of domestic or private nature