Take care with VAT bad debt relief

The issue

For those VAT registered businesses which do not use the cash accounting scheme (most of them), care needs to be taken with VAT bad debt relief. VAT is usually payable for the quarter in which an invoice is issued and so when a debt goes bad a business needs to work out how to recover any VAT paid on that debt. There are correct and incorrect ways of doing this.

Credit notes (incorrect)

Credit notes are appropriate when reductions to an invoice are agreed with a customer and in these cases the output tax figure in the return can validly be reduced.

These are not appropriate in a bad debt scenario and in those cases relief specifically needs to be claimed.

Bad debt relief

This can be reclaimed when the following conditions apply:

  1. Output tax must have been paid on an earlier return.

  2. The invoice is more than six months overdue.

  3. The debt has been accounted for as a bad debt.

  4. The debt has not been sold, factored or assigned.

  5. The invoice cannot be more than four years and six months old at the time of the claim.

The claim needs to be made by increasing the input tax figure in Box 4 of the return.

Flat rate scheme users

Strangely even flat rate users who use the cash based turnover method can reclaim bad debt relief. This is counter-intuitive because here VAT is only paid when cash is received and so how can there be a relief? It works like this:


Janine invoices a client £5,000 (+ VAT) which goes bad. She operates under that flat rate scheme using a rate of 12%. Given that she would have received VAT of £1,000 if she had been paid but only would have paid £720 VAT (12% of £6,000 gross income) she is £280 ‘out of pocket’ and therefore she can claim this back under the bad debt relief rules. As I said, this is quite a strange one.

Forbes Dawson comment

Businesses with significant bad debts should be reviewing how they deal with these in their VAT returns and seeking to amend any errors or make any claims that have been overlooked. Flat rate users are particularly prone to making mistakes here and may well have missed out on some valuable refunds if they do not receive sound VAT advice.




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