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VAT relief on bad debts

The past two years have seen significant financial hardship & your business may have incurred bad debts. If so, you'll need to take certain steps to make sure you comply with VAT regulations. rradar tax expert Steve Tetley explains the details.

Claiming VAT relief on Bad Debts

For a lot of businesses, the past two years have seen significant financial hardship. While your business has survived, many others have not, and this may include customers and clients. That, in turn may mean that you have incurred bad debts. While you may have reconciled yourself to this eventuality and built it into your financial planning, you will still need to take certain steps to make sure you remain compliant with VAT regulations.

In this article, rradar tax expert Steve Tetley explains what action you need to take to ensure your VAT is correctly accounted for.

When will this apply?

You may be able to claim relief on bad debts if you have made a supply of goods or services to a customer but haven’t been paid.

Relevant law and guidance

You can find the law that governs bad debt relief in:

· Sections 26a and 36 of the VAT Act 1994 and

· The VAT Regulations 1995, Parts XIX, XIXA and XIXB.

HMRC have published guidance, and this can be accessed via VAT Notice 700/18.

What are the time limits for applying?

You must claim relief for bad debts within 4 years and 6 months of:

· the date payment was due, or

· the date of supply for VAT purposes,

whichever is the later.

In what circumstances can I claim bad debt relief?

You can claim relief for bad debts providing the following conditions are met:

1. The VAT must have already been accounted and paid to HMRC.

2. The VAT must have been written off in the day-to-day accounts and transferred to a separate bad debt account.

3. The value of the supply must not be more than the customary selling price.

4. The debt must not have been paid, sold or factored.

5. The debt must have been unpaid for a least 6 months after the

a. date payment was originally due, or

b. date of supply,

whichever is the later.

One exclusion is if your business accounts for VAT under the Cash Accounting Scheme. Under this scheme, VAT is only accounted for on the amounts actually received, so bad debt relief is not appropriate.

How can I claim bad debt relief?

Relief for the bad debt can be claimed via Box 4 on the VAT return.

What records do I need to keep?

If bad debt relief has been claimed, you must keep the following records:

· A copy of the original VAT invoice to which the bad debt refers

· A separate bad debt account to include the following:

a. the amount written off as a bad debt

b. the amount of bad debt relief claimed

c. the VAT period in which the relief is claimed

d. the total amount of VAT charged

e. the VAT period in which the VAT was originally accounted for

f. any payments received for this supply

g. the name of the customer

h. the date and invoice number to which the bad debt relates to

i. a copy of any notification sent to the customer (see below)

The records listed above should be 4 years from the date the claim is made although it should be remembered that there is a general requirement to retain business records for a 6-year period.

Do I need to notify the debtor?

There is no longer a requirement to formally notify the debtor of your claim to VAT bad debt relief. The requirement to issue a formal notification ceased with effect from 30th April 1997.

How much can I claim?

The amount of relief you can claim depends on the outstanding amount in respect of the supply which remains unpaid. If you have received payment for part of the debt, you can only claim a refund on the VAT relating to the unpaid element.

If there have been multiple supplies and payments, then there are rules to attribute the payments – see 3.4 of VAT Notice 700/18.

If an amount is also owed to the debtor and is netted off against the outstanding debt, then the net amount of VAT can be claimed as bad debt relief. For example, if your business is owed £1,000 (including VAT) and nets off £250 owed to the debtor, you can claim VAT bad debt relief as follows:

£750 x 1/6 (VAT at 20%) = £125.

If the debtor refuses to pay the VAT element of a debt, then you can only claim the VAT at 20% on the outstanding amount.

What about other taxes?

The rules for Income Tax (IT) and Corporation Tax (CT) are slightly more relaxed than the VAT rules. For IT and CT, you can claim relief against trading profits on a doubtful debt rather than just when a debt is deemed to be bad and is written off. CT deductions are covered by the loan relationship rules but the outcome is essentially the same as for IT.