VAT - Bad debts / Refunds / Non-refundable fees / Cancellations / Prompt payments

Your business may sometimes give refunds or raise credit notes, e.g. if goods are returned by customers or an invoice contains a pricing error. How is this different to bad debt relief, and why is it important to make a distinction?

A credit situation involves a whole or part reduction in the invoice amount - a bad debt is where the customer doesn’t pay. Bad debt relief claims are subject to time limits, so impress upon your client the difference between the two. If HMRC reclassifies a credit as a bad debt, it might be too late to claim relief.

It is important to be clear about the difference between a “credit” situation and a “bad debt” outcome. In the latter case, you expect your customer to pay their dues but for some reason, some or all of the payment is not made. This means that any output tax you account for on a VAT return can be claimed back on a future return as long as two conditions are met:

  • the sales invoice for the original sale is at least six months overdue for payment; and
  • the invoice has been written off in the accounts of the supplier, i.e. a credit to debtors and a bad debt expense entry is made in the profit and loss account.

Pro advice. Be clear with your clients that the key date is when the invoice is six months after the due payment date, and not six months from the date of the sales invoice. So, if an invoice is raised on 31 March 2017 on 60-day payment terms, the earliest possible date for a bad debt claim for VAT purposes is the VAT return that includes 30 November 2017.

If a business uses the cash accounting scheme, then bad debt relief is automatic. Note that you do not issue a credit note in bad debt situations.