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VAT Notice 700/18

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Avoiding costly mistakes with bad debt relief

Credit notes

Some business owners think that a credit note can be issued to adjust an unpaid sales invoice. This is not correct. A credit note is only appropriate if:

• you have made a supply of goods and some or all of the goods have been returned
• an invoice has wrongly charged the quantity of goods or services you have supplied; or
• you have made a pricing error.

Tip. VAT on credit notes is recorded by reducing the Box 1 output tax figure on your return. A claim for bad debt relief is made by increasing the input tax figure in Box 4. For sales credits, you also reduce the Box 6 outputs figure but no adjustment is made in the value boxes for a bad debt relief claim because a supply of goods or services has still taken place.

Bad debts

To claim bad debt relief you must go through a number of different hurdles per VAT Notice 700/18 (see The next step ):

• you must have paid output tax on an earlier VAT return, i.e. you do not use the cash accounting scheme where bad debt relief is automatic
• the invoice is more than six months overdue for payment
• you have written off the invoice in your sales ledger, i.e. debited a bad debt expense account
• the debt must not have been sold, factored or assigned under a valid legal agreement.

Tip. If you don’t show a payment date on your invoice, the invoice date is relevant as far as the six-month time limit is concerned.

Trap. If any unpaid invoices in your sales ledger are zero-rated or exempt, you cannot claim any bad debt relief.

Time limits

It is important that you regularly review your sales ledger to identify potential bad debts. But there is no problem making a historic claim for invoices that are still showing in your sales ledger, as long as the payment date (or invoice date if you didn’t specify one) for the invoice is no older than four years and six months at the time you claim relief.

Flat rate scheme users

If you use the flat rate scheme (FRS), and the cash based turnover method, you don’t include VAT on a return until your customers pay their dues. You would therefore expect that no bad debt relief can be claimed in such cases. However, there is an unexpected windfall.

Example. Marie uses the FRS with a rate of 12%. She completes calendar quarter VAT returns and uses the cash based turnover method. She raised an invoice for £5,000 plus £1,000 VAT on 31 December 2018 on 30-day payment terms, which she wrote off as a bad debt on 1 March 2020. She claims relief on her March 2020 VAT return. If the invoice had been paid, she would have collected £1,000 of tax from her customer and included £720 on her VAT return (gross income of £6,000 x 12%). In the absence of payment, she can claim the difference of £280 (£1,000 less £720) under the bad debt relief rules.

For a link to VAT Notice 700/18, visit http://tipsandadvice-vat.co.uk/download (VA 10.05.02).