Suffering a bad debt can have a significant impact on a business, both to profits and importantly cash flow. The recent compulsory liquidation of Carillion plc on 15 January 2018 is a high profile example and there can be potentially significant knock-on effects to a business when a business that it has traded with collapses.
Although clearly not always possible, preventing bad debts from arising in the first place is the first important step. Ways to help achieve this include:
- Setting credit limits. Rather than extending the credit limit when a customer wants to order more, consider asking them to pay the additional balance in advance.
- Staying organised and implementing a credit control and accounting process can help your business issue invoices and chase late payments as and when they arise.
- Credit checking customers.
- Requesting trade references for customers.
- Resolving any issues arising or disputes quickly.
If unfortunate to then suffer a bad debt it is the amount net of VAT that becomes the cost to the business. If operating the cash basis VAT is only accounted for when the money has actually been received and thus VAT on a bad debt is never paid over. If accounting for VAT on the invoice basis then the VAT will have been paid over to HMRC and thus can be reclaimed. Although there are others, the main conditions to claim VAT bad debt relief are as follows:
- You must have already accounted for the VAT and paid this to HMRC.
- The debt must have remained unpaid for a period of six months after the later of the time payment was due and payable and the date of the supply.
- You must have written off the debt in your day to day VAT accounts and transferred it to a separate bad debt account.
- The debt must not have been paid, sold or factored under a valid legal assignment.
To claim a refund you should include the amount of the VAT you are claiming in Box 4 of your VAT return that covers the date when you fulfill the conditions to make a claim. Books and records need to be kept to support the claim, to include a copy of the VAT invoice(s) and full details of the amount written off in the bad debt account.
For VAT purposes, therefore, a period of six months must elapse before the VAT can be claimed. However, for annual accounts purposes provision can be made once there is a reasonable likelihood that a debt will not be recovered. A debt can, therefore, be provided against – enabling tax relief to be claimed through the resulting reduction in business profits – without actually writing off the debt in the records, as required to claim back the VAT. Providing us with details of potential bad debts is important to ensure that accounts do not imprudently overstate profits and also to avoid paying tax to HMRC on resulting bad debts.
If you would like further information then please contact us.