How do bad debts affect my VAT Return?

A bad, or irrecoverable, debt is an amount owed by a customer that is unlikely ever to be received.

For VAT purposes, a debt does not become a irrecoverable simply because the payment is late. However, where a customer has failed to pay an invoice and the debt is unlikely to be recovered, a business may be able to claim VAT Bad Debt Relief and recover the VAT previously paid to HMRC.

You may be able to reclaim VAT for bad debts on your VAT return, through HMRC’s Bad Debt Relief scheme. In order to do so, the debt must meet all the following criteria:

• remain unpaid for at least six months;
• be less than four years and six months old;
• have been written off in your accounts as a bad/irrecoverable debt;

and

• relate to VAT that has already been accounted for and paid to HMRC.

If these conditions are met, the VAT can normally be reclaimed on your VAT Return.

What if I use the VAT Cash Accounting Scheme?

Many small businesses use the VAT Cash Accounting Scheme. Under this scheme, VAT on sales is generally only due to HMRC once it has been received from the customer.

As a result, bad debts relief is negated because the VAT due on a bad debt won’t have been paid to HMRC in the first place.

If you use Making Tax Digital (MTD)-compatible accounting software, the Bad Debt Relief adjustment may be calculated and posted automatically once the debt has been written off. However, you should still check that the VAT has been reported correctly before submitting your VAT Return.

How the VAT claim is reported

The original sale and its associated VAT remain unchanged in the VAT Return in which they were first reported.

Instead, the VAT element of the bad debt is reclaimed through Box 4 (VAT reclaimed on purchases and other inputs).

For example, if a customer owes:

• Net amount: £623.60
• VAT: £124.72
• Total debt: £748.32

and the debt qualifies for VAT Bad Debt Relief, the reclaimable VAT amount of £124.72 should be reflected in Box 4.

What should I check before submitting?

Before submitting your VAT Return, confirm that:

• the debt has been written off in your accounts
• the debt meets HMRC’s Bad Debt Relief criteria
• only the VAT element of the bad debt has been reclaimed
• the adjustment has been reflected in Box 4.

If you have claimed VAT Bad Debt Relief and later recover all or part of the debt, you must repay the corresponding VAT to HMRC.

For example, if you reclaimed VAT on an unpaid invoice and the customer subsequently pays the outstanding balance, the VAT previously recovered can no longer be claimed and must be accounted for on a later VAT Return.

If you use MTD-compatible accounting software, check that the debt recovery has been recorded correctly and that any VAT adjustment has been reflected in the VAT Return before submission.

If only part of the debt is recovered, only the VAT relating to the amount received needs to be repaid to HMRC.