VAT - 11.05.2006

Bad debts

Bad debt relief

Scenario. Let’s assume that when you make a taxable supply to a customer you become liable to account for VAT on it. With a VAT return completed on an invoice basis then you will usually end up paying across tax to the VATman before your customer puts you in funds. What if you decide the customer isn’t going to pay. Is there a way you can get this VAT back?

Rule of thumb. A claim for bad debt relief can be made six months after the date payment became due.

For example, if you supplied goods to a customer worth £11,750 (£10,000 goods plus £1,750 VAT) on September 30, 2005 with 30-day payment terms, the earliest you could claim back the £1,750 VAT, if it proved to be a bad debt, would have been April 2006. With a VAT return due for the quarter ended June 30, 2006 your claim would affect any VAT due/payable on July 31, 2006.

Tip 1. After chasing customers for money, put the doubtful ones on a “get the VAT back” list showing the six months’ claim date and the amount of VAT itself. Keep updating this and use it to monitor your VAT reclaim.

Tip 2. Review older debts and check that an appropriate claim has been made. You can claim up to three years and six months after payment was due or the date of supply (if later).

Paperwork

Time’s up. When the six months are up, you need to record your claim for VAT purposes in a “refunds for bad debts account”. This is not necessarily part of the normal accounting system. It should be backed up by a separate file, which has details of any claims you make. A VAT inspection officer will expect to examine this record during a visit.

Boxed in. The total amount you are claiming is then added to the Input box of your VAT return. You don’t need to separately notify the VATman that you are making such a claim.

No letter. You don’t have to send a letter to your debtor telling them that the debt has been written off for VAT purposes.

Payments after claim. If the debtor subsequently pays the debt or part of it you will need to adjust your VAT return accordingly to pay back a proportionate part of your original claim to the VATman. You do this by adding the VAT figure to Box 1 of your return.

What if you are the customer?

Warning. If you are the customer you need to monitor the payment of your suppliers’ invoices because once a purchase invoice is six months past the due date, you will have to pay back the input VAT you claimed to the VATman (until such time as full payment is made).

Tip. Don’t just introduce a routine for picking out bad debt. Ensure for VAT purposes that you have a system in place to monitor payments, or part payments, to your suppliers. Once these are six months’ overdue you will have to adjust your input VAT claim (by making a negative entry in Box 4 of your VAT return).

Visit. You can be sure that the VATman will check that this has been done correctly, and if it hasn’t, he will assess you for the error, plus interest.