DCA Q&A – HOW DO I TREAT A BAD DEBT FOR TAX?

Q: I’m running a small business as a sole trader and in the midst of doing my accounts for 2011, I stumbled across a problem: bad debts. One or two of my earliest clients simply didn’t pay up, even though I chased them steadily. The amounts involved weren’t huge, so it wasn’t worth my while seeking a court judgement – which probably wouldn’t have led to me getting paid anyway. But what’s the best way to account for this with the taxman?

 

A: This is a common enough problem. From an accounts point of view, you can write off bad debts with an internal credit note. On the note, include the invoice number, the client, and why you’re writing off the debt – whether it’s because of the age of the debt, a dispute with the client, or their inability to pay.

 

If you account for VAT on an invoice basis, you can reclaim the VAT paid on bad debts excluding hire purchase arrangements that go sour. You must be in a position to demonstrate that you have taken all reasonable steps to recover the bad debt, and that the debt has been written off in your financial accounts.

 

Also, the debtor cannot be someone you have a connection with – this includes relatives, a business partner and his or her spouse, or a person defined has having control over you (or vice-versa). This can, of course, be a cash-flow benefit, but bear in mind that the Revenue may well seek copies of credit notes – especially if your VAT goes into a repayment situation. Adopting this approach doesn’t mean that you can no longer chase the debt. If you’re lucky enough to have a bad debt pay up, you can reverse the credit note by invoicing again.

 

In the longer term, you may well need some assistance in your credit control – while many businesses are waiting longer for payment, you should never find yourself in the position of routinely writing off debts. You can take a look at our articlehere on managing your cash flow. If you’d like to hand off this aspect of the business to focus on sales and servicing clients, DCA Accountants and Business Advisors run a cash collection service for our clients. Do feel free to contact us to find out more.