With times as tough as they are right now, several clients have had to approach SARS to see if they can get their tax liability reduced.

Whether it is Income Tax, VAT or PAYE that is owing, SARS will look at the taxpayer’s ability (or not) to pay, and will come to whatever arrangement gives SARS the best achievable result. In other words, they would rather have half a loaf than no bread at all.

The result is often a write-off of part of the debt, and this gives rise to an accounting problem.

Firstly, what is the book entry?

The liability is sitting as a Credit in the Balance Sheet. So, if SARS reduces it, then that requires a Debit to the liability account and a Credit to the Income Statement. In other words the amount of debt forgiven is reflected as “Other income”.

The next question is whether this income is, itself, taxable.

Normally, the forgiveness of a debt by a creditor is a CGT event and the debtor, my client in these cases, becomes liable to pay Capital Gains Tax. This is detailed in 12C of the Eigth Schedule of the Income Tax Act.

However, 12C first defines a “debt” as “any amount that is owed by a person ……….., but does not include a tax debt as defined in section 1 of the Tax Administration Act”

and the definition of a tax debt in s1 is “an amount referred to in section 169(1)”

and s169(1) says “An amount of tax due or payable in terms of a tax Act is a tax debt due to SARS …………..”

So, once you have followed this tortuous trail, you can conclude that the SARS compromise is free of tax and will be reflected as tax free income in the tax return.