Most small businesses in Wigan and the North West have at least one invoice that has gone quiet. A customer who stopped answering the phone, a job that ended in a dispute, or a company that has since gone into liquidation. What many owners do not realise is that, even if the cash never arrives, you may not have to lose the VAT and tax on that sale as well. Bad debt relief lets you get some of it back, and the run-up to Christmas and the year end is a good time to go through your sales ledger and claim what you are entitled to.

Why an unpaid invoice can cost you twice

If you are VAT-registered and use standard (invoice-based) VAT accounting, you pay the VAT on a sale to HMRC on the return for the period you issued the invoice, whether or not the customer has paid you. If they never pay, you have handed over VAT you never collected. On top of that, the sale is counted in your profits for Corporation Tax or Income Tax until you take it back out. Bad debt relief is how you correct both.

Claiming VAT bad debt relief

You can reclaim the VAT you paid on an unpaid invoice if all of these apply:

• You have already accounted for the VAT and paid it to HMRC.
• At least six months have passed since the later of the date payment was due and the date of the sale.
• You have written the debt off in your accounts and recorded it in a separate refunds-for-bad-debts account in your VAT records.
• You have not sold the debt on, for example to a factoring company.
• You claim within four years and six months of the later of the payment due date and the date of the sale.

The claim goes in Box 4 of your VAT return, the same box as the VAT you reclaim on purchases. As all VAT-registered businesses now file through Making Tax Digital software, your bookkeeping package (Xero, QuickBooks and the like) will usually handle this when the invoice is written off correctly, but it is worth checking the figure before you submit. If the customer pays you later, even in part, you must repay the matching VAT to HMRC.

If you use the VAT cash accounting scheme, you only pay VAT when your customer pays you, so there is nothing to reclaim. That is one reason cash accounting can suit businesses that often wait a long time to be paid. Our VAT services page explains how we help choose the right scheme.

The other side: if you owe a supplier

The rule works both ways. If you have reclaimed VAT on a supplier’s invoice and still have not paid it six months after the later of the due date and the date of supply, you must repay that input VAT to HMRC on your next return. Once you do pay the supplier, you can claim it again. It is easy to miss, so it is worth a look when you review your purchase ledger.

Bad debts and Corporation Tax or Income Tax

For Corporation Tax (limited companies) and Income Tax (sole traders and partnerships), you can deduct a bad debt from your profits when it is specifically written off or specifically provided for, meaning you have identified the actual invoice and have good reason to think it will not be paid. A general provision, such as setting aside 5% of all debtors “just in case”, is not allowed for tax.

The timing matters. Reviewing debtors before your year end, and writing off the ones that are clearly lost, means the deduction falls in the right year and your tax bill reflects the money you actually received. If you want help getting the accounts right, see our Corporation Tax page.

Before you write it off: chase it properly

Writing off a debt for tax does not stop you chasing it. Under the Late Payment of Commercial Debts (Interest) Act 1998, one business can usually charge another statutory interest at 8% above the Bank of England base rate on a late invoice, plus fixed compensation of £40 for debts under £1,000, £70 for debts from £1,000 to £9,999.99, and £100 for debts of £10,000 or more. Sometimes simply mentioning this in a final reminder is enough to get paid. We covered more practical tips in our earlier article on managing late payments.

If the customer has gone into liquidation or administration, send your claim to the insolvency practitioner dealing with the case. You can still claim VAT bad debt relief once the six-month point has passed.

A quick year-end checklist

• Run an aged debtors report and list every invoice more than six months overdue.
• Note for each one whether it is still recoverable, disputed, or clearly lost.
• Write off the lost ones in your bookkeeping software and record them for VAT.
• Check the bad debt relief figure on your next VAT return before you submit it.
• Check your purchase ledger for supplier invoices unpaid for more than six months.
• Keep copies of the invoices, reminders and any insolvency letters as evidence.

Keeping your ledgers up to date through the year makes all of this much easier. Our monthly accounts service gives you an up-to-date debtors list every month, and our VAT return service makes sure reliefs like this are not missed. For more ways to keep cash moving, see our autumn cashflow and VAT checklist.

Talk to a local accountant in Wigan

If you have unpaid invoices on your books and are not sure what you can claim, CMA Accountancy can review your sales ledger, put the bad debt relief through your VAT return and make sure your accounts and tax return reflect what you have actually been paid. Find out more about working with an accountant in Wigan, or call us on 01257 255521 or email [email protected]. We are based in Appley Bridge, Wigan, and work with small businesses right across the North West.