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Saving cash flow through VAT - Bad debt relief. By David Miller

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2nd Oct 2006
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David Miller, of Barnard Atkins Limited, considers the benefits of VAT bad debt relief and provides some practical advice for businesses.

Companies who have not been paid for taxable supplies within six months may be able to claim bad debt relief (BDR). Basically BDR allows companies who have accounted for the output tax on their supplies to recover this on their VAT return until such time they are paid in full or part.

Conditions of making a claim

To be eligible to make a claim there are of course certain conditions that Customs have put in place before BDR can be claimed:

  • Output tax must have been paid to Customs
  • Debt must be written off in the day to day VAT accounts and transferred it to a separate bad debt account BUT NOTE this does not mean the debt has been written off by the business
  • The value of the supply must only be the normal selling price
  • The debt must not have been paid, sold or factored under a valid legal assignment
  • The debt must have remained unpaid for a period of six months after the payment was due and payable or the date of the supply, which ever is later
  • Please note that BDR is subject to the three year capping rule therefore bad debts older than this cannot be claimed
  • So long as output tax has been paid to Customs, the debt is more than six months old (but less than three years old) and the debt has not been factored then BDR can usually be claimed.

    Advice: If you haven't already set up a bad debt account, do so and look back over three years to see if you are entitled to any claims.

    Record keeping requirements

    As mentioned above one of the requirements is to keep a bad debt account, in addition to this a copy of the VAT sales invoice should also be retained. A separate record of BDR claimed by the business should also be made.

    Making a claim

    To make a claim for BDR you just have to increase box four of the current VAT return by the relevant amount. This is regardless of whether the business is on the flat rate scheme or if the amount of the claim is over £2000.

    What if I have been only partially paid?

    If there has only been partial payment of the debt then the supplier is still able to claim BDR on the outstanding amount. The outstanding amount is treated as a gross amount and the reclaim by the supplier would a percentage of that depending on the vat liability of their supply.

    For example:

  • A supply with a 17.5% VAT liability means the supplier would be able to reclaim 7/47 of the remaining debt
  • A supply with a 5% VAT liability means the supplier would be able to reclaim 1/21 of the remaining debt
  • Impact of BDR on the purchaser

    From 1st January 2003 there has been a requirement that input tax should be paid back to Customs when the supplier for the goods or services has not been paid within six months. This provision is completely independent of whether the supplier has claimed bad debt relief or not. To make an adjustment the company should include a negative figure in box four of the return.

    Advice: Look through your records to see if any input tax is due back to Customs. This is particularly relevant as HMRC will assess if creditors have not been adjusted BUT won't necessarily off-set where claims have not been made!

    If the supplier has not been paid due to a dispute with the supplier, input tax would still have to be repaid if the debt is older than six months old. The only way to get around this is by negotiating an extension on the due date for payment. This will mean that the customer would not be required to repay input tax until six months after this revised date. However, this would also mean that the supplier would not be entitled to BDR until that revised date either.

    Advice: If you are in dispute with a supplier try and negotiate an extension onto the payment due date to protect the input tax position.

    Use of credit notes instead of bad debt relief

    It is not possible to issue a credit note because a customer has not paid rather than use the BDR facility as credit notes are only applicable where for example there has been an over charge or an agreed revision of the value of the supply.

    Is it possible to claim BDR if I have deregistered?

    Of course but you must ensure that you are entitled to a claim by the conditions above and write to your local VAT office with:

  • The old VAT registration number
  • The name and address of the debtor(s)
  • The amount of refund you are entitled
  • Copies of evidence such as invoices
  • Proof that the debt has remained unpaid for 6
  • Proof that you have a separate bad debt ledger
  • Advice: If you have deregistered from VAT it is worth looking through the records to determine whether a claim can be made remembering that claims can go back three years from the current date.

    For further information please contact David Miller or Steve Burke at Barnard Atkins Limited by e-mailing [email protected] or [email protected]

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    By User deleted
    02nd Oct 2006 17:04

    Bad debt on flat rate scheme
    I have been in contact with HMRC re bad debts whilst on the flat rate scheme. They have assured me that you make the claim exactly the same as if you wern't on the flat rate scheme, ie the full VAT on the invoice in boxes 4 and 7.

    It seems very generous to claim back more VAT than you had originally paid. Has anybody else been told this, or otherwise ?

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    avatar
    By astjprice
    09th Oct 2006 20:50

    Here is what my book says
    This is comment from chapter 35, page 559, of the 2006/07 edition of my book Value Added Tax just issued by Tottel Publishing now a mere £19.95!

    It sounds as if you did not get the full story -- as is so often the case!

    Bad debt relief under the Scheme
    The bad debt relief rules, as described in Chapter 16, apply in the normal way if you calculate your Scheme turnover based on invoices under the Basic Turnover Method and the invoice remains unpaid after six months.
    If you use the Cash Based Turnover Method, you get a special additional relief if you have written off the debt. HMRC also say you must not have accounted for the VAT on it, which, of course, you will not have done under this method. Presumably, they mean that you must not have accounted for VAT under the normal rules prior to joining the Scheme.
    You deduct, from the VAT at the normal rate, the sum you would have paid under the Scheme if your customer had paid up. The balance is a special allowance, which you can reclaim as input tax on your next VAT return. Thus, on an invoice of £1,000, the VAT is £175. If your Flat Rate % is 10%, that is £117.50.

    A St John Price FCA

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