Recovering VAT on bad debts

Before recovering VAT on bad debts one of the first points to consider is whether monies owed to you qualify as a bad debt for VAT purposes

Recovering VAT on bad debts

In order to be considered a bad debt for VAT purposes, the following conditions must apply:

  • There has been a supply of goods or services by a taxable person.
  • The VAT on the supply of goods or services had been paid to HMRC
  • The whole or part of the supply has been written off as a bad debt in the VAT account and has been transferred to a separate bad debt account. However the accounts do not necessarily have to show it as a debt that is unlikely to be paid.
  • At least 6 months has passed from the date of the supply in question
  • The amount charged for the supply was not excessive. In other words it was charged at the open market value.

Having covered the conditions we'll now consider how recovering VAT on bad debts applies to different VAT schemes.

Recovering VAT on bad debts - standard accounting for VAT

In this case you pay output VAT typically and reclaim input VAT on the time of supply. In other words the invoice date not when payments are made.

When recovering VAT on bad debts on your VAT return the procedure is as follows:

  • If the full amount on the invoice is a bad debt, then you add the VAT to box 4 (VAT reclaimed etc) of your VAT return The net amount of the invoice is is added to box 7 (total value of purchases).
  • If the debt has been partly paid the amount outstanding multiplied by the VAT fraction is added to box 4. The fraction is 1/6 for standard rated supplies and 1/21 for reduced rated supplies. You then add the outstanding debt less the amount of VAT adjusted in box 4 to box 7.

Recovering VAT on bad debts - cash accounting for VAT

The situation here is even more straightforward. If you pay and recover VAT using the cash accounting scheme. you won't have been paid. So in this case, there is no VAT recovery involved.

The same treatment applies where one of your invoices has only been partly paid.

Recovering VAT on bad debts - VAT flat rate scheme

The usual bad debt rules also apply if you're on the Flat Rate Scheme and you use the invoice basis

Although VAT payable to HMRC on your sales may be calculated using the lower flat rate scheme percentage rate, this does not mean the bad debt relief is restricted. This is because the reduction in your percentage is in recognition of purchases that you don't recover VAT from.

HMRC recognise it would be unfair to restrict bad debt relief to your reduced percentage rate. Therefore the same adjustments are made for users of the invoice basis as for users of standard accounting (see above).

If you calculate VAT on the cash basis you are entitled to a bad debt adjustment. The conditions for bad debt relief are adapted for the cash basis. In this case, output VAT on the sale does not need to have been paid to HMRC for relief to be claimed.

The adjustment allowed is the difference between the VAT on the outstanding debt, calculated using the VAT fraction (see above) and the Flat Rate Scheme percentage of the VAT on the outstanding debt.

Recovering VAT on bad debts - VAT margin schemes

When operating a VAT margin scheme such as the second-hand goods scheme, you pay VAT on the profit made on the goods which are bought and sold.

If any of your sale proceeds are written off as a bad debt, VAT bad debt relief can be claimed as follows:

  • When the outstanding debt is greater than the profit margin made, the VAT can be recovered in full.
  • If the outstanding debt is less than the profit margin, multiple the debt by the VAT fraction to calculate the recoverable amount.

The VAT relief is added to box 4 and the outstanding debt less the box 4 adjustment is added to box 7 of the VAT return

Recovering VAT on bad debts - other points

What happens if I've deregistered for VAT?

You can still claim bad debt relief if you have deregistered for VAT, as long as you meet the conditions detailed above. However if you made a bad debt claim whilst registered and receive a payment after deregistering, you must pay the VAT to HMRC.

Can I just issue a credit note instead?

It might be tempting to simply enter a credit note into you accounting system. However, you should only issue a credit note if there is a genuine mistake, overcharge, or agreed price reduction.

You cannot issue a credit note simply because you have an outstanding debtor, to speed up or simplify bad debt relief.

What records should I  keep?

HMRC have detailed the records that should be retained for a claim here. These records should be kept for a minimum of 4 years, though there is a standard requirement to retain records for 6 years. We'd therefore recommended that this is the minimum period for which records should be retained.

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at richard@tfaaccountants.co.uk.

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