Maximise tax relief for bad debts

Bad debts in accounts

As you’re probably aware, there are comprehensive rules on how companies prepare their accounts. Overall they must be a true and fair reflection of its transactions during the accounting period. That means including sales even if the customer hasn’t paid and even if you don’t expect to get paid. For the latter the accounts can, in fact should, include an adjustment for bad debts. However, HMRC may not accept a corresponding tax deduction.

Tax deductible bad debts

Whilst HMRC allows a deduction from taxable profits for bad debts, it takes a tougher approach than accounting rules on what qualifies. For example, it doesn’t allow you to estimate the overall value of bad debts and claim a corresponding deduction, even if it’s almost certain, based on previous years, that your estimate will be accurate. You must carry out a review of each debt.

Effort and reward

HMRC expects you to make a reasonable and proportionate effort to recover the money you’re owed. Of course, the effort you’ll be willing to put in depends on the amounts involved. If what’s owing on an invoice is, say, £100, it’s likely HMRC will accept a couple of automated chaser letters as sufficient evidence for a claim for relief. Conversely, if you’re claiming a tax deduction for a £10,000 debt, HMRC expects you to have been thorough in your attempts to recover it. For example, using a debt collection service and/or taking court action.

If a debtor has gone into liquidation HMRC will usually accept a debt as bad unless there’s an indication that the liquidator will pay some of it. In that case only the amount likely to remain unpaid can be claimed as a bad debt

Timing

You can claim relief for the accounting period in which you decide a debt has become irrecoverable. If you suspect a debt may go bad, try to establish this in the same accounting period as that in which you issued the corresponding invoice. This ensures your company won’t be taxed on unpaid bills.

If you don’t establish a debt as bad until the accounting period following that in which you issued the invoice, you might have to wait another full year for a tax deduction. This is bad news for your company’s cash flow.

To ensure tax relief is received as soon as possible, review your debtors frequently, not just at the end of the financial year.

Having a set timetable for reviewing debts that you can show to HMRC will help your case in the event it challenges your claim that they are bad.

Post-accounting period events

If the status of a debt you thought was bad at the financial year end changes, and before you sign your company’s accounts it is paid or you now expect it to be paid, HMRC will not accept a deduction for bad debt relief. This rule works both ways so you can claim relief on a good debt that turns bad before you approve your accounts.

Before you sign off your company’s accounts get your accounts department to make a final check on the status of debtors.