Even with an improving economy, bad debts remain a reality for many businesses. If you’ve already paid VAT to HMRC on sales invoices that remain unpaid, you could be eligible to claim bad debt relief.
Let’s take a look at how the process works depending on the VAT accounting scheme you use and how you can claim relief when your business faces unpaid invoices.
Cash Accounting Scheme: The Simple Route
If you’re using the cash accounting scheme, dealing with bad debts is straightforward. Under this scheme, output VAT is only declared on your VAT return when you actually receive payment. This means that bad debt relief is automatically applied—you don’t pay VAT on invoices that haven’t been paid.
While this is great for businesses dealing with late payers, the downside is that you can’t claim input VAT until you’ve paid your suppliers. With the invoice accounting scheme, you’d be able to claim input VAT sooner, even if you haven’t paid the supplier yet.
Invoice Accounting Scheme: Claiming Bad Debt Relief
For businesses using the invoice accounting scheme, bad debt relief isn’t automatic. VAT on the issued invoice must already have been paid to HMRC before you can claim relief. To be eligible, the debt must meet these conditions:
- The debt must be at least six months overdue from the date of supply.
- The debt must be written off in your accounts.
- You must claim within four years and six months from when the payment became due.
To claim relief, simply adjust your VAT return for the period when the six-month overdue mark has passed. Include the amount you’re reclaiming along with your input VAT.
If your debtor is later declared insolvent, and you want to make a claim, remember that your claim will be for the VAT-inclusive amount. VAT will still need to be accounted for on any debt recoveries.
What If You’re the Debtor?
If you’re the one who owes money and hasn’t paid, any input VAT you’ve already claimed on supplies must be repaid to HMRC—even if your supplier hasn’t yet reclaimed bad debt relief. While HMRC might not immediately notice if you don’t repay the VAT, it’s something they can check during an enquiry.
Flat Rate Scheme (FRS): VAT Bad Debt Relief
For businesses using the flat rate scheme (FRS), VAT is calculated using a fixed percentage of your gross sales. Even under this scheme, you can benefit from claiming bad debt relief.
Example: Flat Rate Scheme and Bad Debt Relief
James runs his business using the FRS with a percentage rate of 10.5% and operates on the cash accounting scheme. One of his clients goes into administration, owing him £5,000 plus £1,000 VAT.
If James had been paid, he would have declared £630 VAT on his return (i.e. £6,000 gross income x 10.5%). However, since the client didn’t pay, James can claim £370 as compensation for the loss of input VAT he would have otherwise incurred using the invoice accounting method.
Zero-Rated Sales and Bad Debt Relief
The rules for bad debt relief only apply to VAT charged to the customer. This means if your business makes zero-rated supplies under the FRS, you won’t be eligible for bad debt relief, and FRS VAT will still be payable.
However, under the cash basis, when you write off a bad debt, the FRS VAT will become payable, but the bad debt regulations won’t apply. This means you can either ignore (if using cash accounting) or reclaim (if using invoice accounting) the FRS VAT on the bad debt.
Key Practical Point: When Does the Six-Month Period Start?
The six-month period for bad debt relief starts from the due date of the invoice. For example, if goods were delivered on 25 June, the invoice issued on 30 June, and the payment terms were 14 days, the six-month period would begin on 13 July.
Need Help Managing VAT Bad Debt Relief?
Handling bad debts and VAT can be tricky, but knowing when and how to claim relief can save your business money. If you need assistance navigating the process or ensuring you’re claiming relief correctly, get in touch with Jon and the team. We’re here to help you manage your VAT obligations and maximise your reliefs.
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Any questions?
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