VAT on Bad Debts: When and How You Can Reclaim the VAT

You have done the work, raised the invoice and accounted for the VAT to HMRC. Then the customer fails to pay. Although VAT Bad Debt Relief cannot recover the lost sale itself, it may allow your business to reclaim the VAT you have already paid over to HMRC.

This guide explains when UK VAT-registered businesses can claim Bad Debt Relief, how the six-month rule works, what goes into Box 4 of the VAT return and what happens if the customer later pays. It also covers part payments, factoring, security and the records HMRC expects you to keep.

For the detailed rules, see HMRC VAT Notice 700/18: Relief from VAT on Bad Debts.

What Is VAT Bad Debt Relief?

VAT Bad Debt Relief allows a business to recover output VAT it has already accounted for and paid to HMRC where the customer has not paid for the underlying goods or services.

It is important to distinguish this from writing off the commercial loss. The relief only deals with the VAT element of the unpaid amount. The remaining debt is still a separate accounting and debt-recovery issue.

Good bookkeeping records are particularly important because the claim depends on showing when the supply was made, when payment became due, what has been paid and when the debt was written off.

The Main Conditions for Claiming VAT Bad Debt Relief

HMRC sets several conditions that must be satisfied before a claim can be made. For a typical modern transaction, the key requirements are:

• You must already have accounted for the VAT on the supply and paid it to HMRC.
• The debt must have been written off in your day-to-day VAT records and transferred to a separate bad debt account.
• The value of the supply must not exceed its customary selling price.
• The debt must not have been paid, sold or factored under an absolute legal assignment.
• The debt must have remained unpaid for at least six months after the relevant date.

If you use the VAT Cash Accounting Scheme, Bad Debt Relief is generally unnecessary because you normally account for output VAT only when your customer pays you.

How Does the Six-Month Rule Work?

You must wait at least six months from the later of two dates: the date payment was due and payable, or the date of supply.

For example, suppose you supplied services on 1 March and your invoice was due for payment on 31 March. The six-month period normally runs from 31 March because that is the later date.

Your agreed credit terms matter. If you formally give the customer longer to pay, that can change the date from which the six-month period runs.

For supplies made after 30 April 1997, HMRC also applies an overall time limit. A claim must normally be made within four years and six months of the later of the payment due date and the date of supply.

How Do You Claim Bad Debt Relief?

Once all the conditions have been met, include the VAT being reclaimed in Box 4 of the VAT return covering the date on which you became entitled to the relief.

You should not issue a credit note simply because a customer has failed to pay. A credit note is appropriate where there has been a genuine mistake, overcharge or agreed reduction in the value of the supply. An unpaid but otherwise valid invoice is dealt with through Bad Debt Relief.

If your VAT records are maintained digitally, make sure the adjustment is correctly reflected in your accounting software and supported by the underlying bad debt account. Our guide to Making Tax Digital explains the wider digital-record requirements.

How Much VAT Can You Reclaim?

The relief is based on the VAT contained in the amount that remains unpaid.

For a straightforward standard-rated invoice at 20%, an unpaid VAT-inclusive balance of £1,200 contains £200 VAT. If nothing has been paid and the other conditions are met, £200 can be included in Box 4.

What If the Customer Has Made a Part Payment?

If part of the invoice has been paid, you can only claim relief on the VAT relating to the unpaid balance.

For example, suppose an invoice totals £2,400 including £400 VAT. The customer pays £600 and the remaining £1,800 is eventually written off. At a 20% VAT rate, the VAT contained in the outstanding £1,800 is £300, so that is the potential Bad Debt Relief claim.

Where payments cover several invoices, HMRC generally attributes the payment to the earliest supply first unless the customer identifies a particular supply and pays that supply in full.

What If You Hold Security Against the Debt?

If you hold enforceable security against the debt, the value of that security reduces the amount on which Bad Debt Relief can be claimed. If the security cannot be enforced, HMRC allows the full debt to be written off for the purposes of calculating the relief.

Hire-purchase, conditional sale and credit-sale arrangements can involve more complicated allocation rules because there may be separate supplies of goods and finance. Specialist advice is sensible where a sizeable claim involves finance agreements or repossessed goods.

What Happens With Repossessed Goods?

Where goods supplied with finance are repossessed following default, the net proceeds from their sale may need to be taken into account when calculating the unpaid amount. There are exceptions where VAT has been accounted for on the resale of the repossessed goods.

This is one of the areas where a simple 'outstanding invoice divided by six' calculation may produce the wrong result, so check the facts before submitting the claim.

Insurance and Guarantor Payments

If you have taken out insurance against bad debts, a payment from your insurer does not normally reduce your entitlement to Bad Debt Relief. Even where the debt is insured for the VAT-inclusive amount, relief may still be available in full, assuming the other conditions are met.

A payment from a guarantor or another third party is different. That payment reduces the unpaid debt. If the guarantor pays the debt in full, there is no Bad Debt Relief entitlement.

Factoring and Assignment of Debts

Bad Debt Relief is generally unavailable while a debt has been absolutely assigned to a factor because the debt is no longer held by the original supplier.

Where the factoring agreement provides for the debt to be reassigned, relief may become available once the unpaid debt has actually been reassigned to the business. The wording of the factoring agreement therefore matters.

Do You Need to Notify the Customer?

For normal current transactions, you do not generally need to notify the customer when making a Bad Debt Relief claim.

The seven-day customer-notification requirement in VAT Notice 700/18 relates to historic supplies within specific old date ranges. For later supplies, suppliers are not required to notify customers when making a Bad Debt Relief claim.

VAT-registered customers have their own responsibility to monitor unpaid supplier invoices. For modern supplies, they may need to repay input VAT if they have not paid within six months of the relevant date.

What Records Must You Keep?

HMRC requires supporting evidence for the claim, including the relevant VAT invoices or equivalent records and a separate bad debt account.

The bad debt account should show information such as:

• The amount written off.
• The VAT being reclaimed.
• The VAT period in which the relief is claimed.
• The VAT originally charged and the period in which it was accounted for.
• Any payments received.
• The customer's name.
• The relevant invoice date and number.

Specific Bad Debt Relief records must be retained for four years from the date of the claim. This does not replace the general VAT record-retention requirement, which is normally six years.

What If the Customer Pays After You Have Claimed?

A debt that has been written off can sometimes be recovered later. If you receive payment after claiming Bad Debt Relief, you must repay the VAT element relating to that payment.

Record the payment in your separate bad debt account and include the VAT being repaid in Box 1 of the VAT return for the period in which you received the money.

If only part of the debt is recovered, only the appropriate proportion of the relief is repaid.

Bad Debt Relief and the Cash Accounting Scheme

Businesses using the VAT Cash Accounting Scheme generally do not need Bad Debt Relief because output VAT is normally accounted for when payment is received.

If a customer never pays, the business normally has not paid the corresponding output VAT to HMRC in the first place. If you leave the Cash Accounting Scheme, however, separate rules can apply to unpaid supplies, so review the position at that point.

Bad Debt Relief Is Not the Same as Correcting a VAT Error

An unpaid invoice is not automatically an error on an earlier VAT return. If the original sale and VAT treatment were correct, Bad Debt Relief is the appropriate mechanism once its conditions are met.

If the original return itself contained an error, such as too much output VAT being declared because of an incorrect entry, that should instead be dealt with under HMRC's VAT error correction rules. AccountingPreneur's VAT services can help establish which route applies where the position is unclear.

Common VAT Bad Debt Relief Mistakes

• Claiming before six months have elapsed. Check the later of the supply date and payment due date.
• Using a credit note for a genuine unpaid invoice. A bad debt does not by itself reduce the original value of the supply.
• Claiming VAT on amounts already paid. Relief applies only to the unpaid balance.
• Ignoring factoring arrangements or security. These can affect whether and how much you can claim.
• Failing to maintain a separate bad debt account. HMRC specifically requires this supporting record.

Frequently Asked Questions

Can I Reclaim VAT on an Unpaid Invoice?

Potentially, yes. If you have already accounted for and paid the VAT to HMRC, the debt has remained unpaid for the required six-month period, it has been written off and the other conditions are met, Bad Debt Relief may be available.

How Long Do I Have to Claim?

For supplies made after 30 April 1997, the normal deadline is four years and six months from the later of the date payment became due and payable or the date of supply.

Where Does Bad Debt Relief Go on the VAT Return?

The amount of VAT being reclaimed is entered in Box 4 of the relevant VAT return.

Do I Have to Tell My Customer I Have Claimed?

Not for normal current supplies. Customer notification requirements in HMRC's notice relate to historic transactions. For later supplies, the customer has its own obligation to monitor unpaid invoices and any input tax adjustment required.

Final Thoughts

VAT Bad Debt Relief can soften the cash-flow impact of an unpaid invoice, but only when the statutory conditions are followed carefully.

Check the relevant date, wait the required six months, write the debt off correctly, calculate relief only on the unpaid amount and maintain the separate records HMRC requires. If money is recovered later, remember to put the appropriate VAT back through Box 1.

For straightforward invoices, the process is manageable. For factoring, hire-purchase, security, repossession or unusual payment arrangements, getting advice before claiming can prevent a second VAT problem being created while trying to solve the first.

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