How VAT works when you write off an unpaid invoice

When a customer fails to pay an invoice, it's not just your revenue that takes a hit. If you're a VAT-registered business using standard accounting, you will have already paid the VAT from that sale to HMRC. This means you are out of pocket for both the service you delivered and the tax you've forwarded on your client's behalf. Fortunately, HMRC has a process for this exact situation: VAT Bad Debt Relief.

This article provides a comprehensive guide for UK businesses on how to reclaim the VAT on unpaid invoices. We'll cover the strict conditions you must meet, how to calculate and make the claim on your VAT return, the essential records you need to keep, and what to do if a customer pays up after you've already written the debt off. Understanding this process is a crucial part of effective credit control and can make a tangible difference to your cash flow when dealing with non-paying clients.

What is VAT Bad Debt Relief?

VAT Bad Debt Relief is an HMRC provision that allows a VAT-registered business to reclaim the output VAT it has already paid on a sales invoice that is ultimately never paid by the customer.

When you issue a VAT invoice under the standard accounting scheme, you must declare the output VAT on your VAT return for that period, regardless of whether you've received payment from your customer. For example, if you issue a £1,000 + VAT invoice in January, the £200 of VAT is due to HMRC with your Q1 VAT return, even if the invoice isn't paid until May.

If the customer never pays, you're left footing their VAT bill. Bad Debt Relief is the mechanism to correct this. It allows you to claim back that £200 from HMRC, ensuring you are not permanently out of pocket for tax on income you never received. It is important to note that this is a relief on the VAT portion only; it doesn't compensate you for the lost revenue from the main part of the invoice.

The Conditions for Claiming Bad Debt Relief

HMRC sets out strict conditions that must be met before you can claim bad debt relief. You cannot simply decide an invoice is a bad debt and reclaim the VAT. All of the following criteria must be satisfied.

1. The Invoice is Over 6 Months Overdue

This is the most critical condition. You can only claim relief if the invoice is at least six months past its payment due date. The clock starts from the due date, not the invoice date.

• Example: You issue an invoice on 1st March with 30-day payment terms. The due date is 31st March. The six-month waiting period begins on 1st April. You would not be eligible to claim bad debt relief until after 30th September.

This six-month period gives the customer ample time to pay and for you to conduct your credit control process. You cannot claim earlier, even if you are certain the customer will not pay (with one exception for formal insolvency, covered later).

2. The Debt is Written Off in Your Accounts

You must formally write the debt off in your business's day-to-day accounts. This means moving the value of the debt from your debtor ledger (accounts receivable) to a separate bad debt account. This is a crucial bookkeeping step that demonstrates your intention to no longer pursue the amount. Simply making a mental note is not enough; there must be an accounting entry.

3. The VAT Was Originally Paid to HMRC

You must have already accounted for the VAT on the sale and paid it to HMRC on a previous VAT return. If you use the VAT Cash Accounting Scheme, you do not pay VAT until you are paid by your customer. Therefore, if you are never paid, no VAT is ever forwarded to HMRC, and there is nothing to reclaim. Bad Debt Relief does not apply to businesses using the Cash Accounting Scheme.

4. The Goods or Services Were Actually Supplied

You must have fulfilled your end of the contract. You cannot claim relief on an invoice for goods or services that you never delivered.

5. The Debt Has Not Been Sold or Factored

You cannot claim relief if you have sold the debt on to a third party, such as a factoring company. If you have sold the debt "without recourse", you have received payment from the finance company and transferred the risk to them, so you have not suffered a loss. The rules can be complex for "with recourse" factoring (where the debt is returned to you if uncollected), and you should seek advice from your accountant.

6. The Property in the Goods Has Passed to the Customer

For supplies of goods, ownership must have legally passed to the customer. If your terms and conditions include a "retention of title" clause (stating the goods remain your property until paid for) and you have repossessed the goods, you cannot claim bad debt relief.

How to Calculate and Claim the Relief

Once you've confirmed all the conditions are met, the calculation and claim process is straightforward.

Calculating the VAT Amount

You can only reclaim the VAT portion of the invoice. To find this, you use the VAT fraction that was applicable at the time of the supply. For a standard 20% VAT rate, the fraction is 1/6.

• Formula: Total Unpaid Invoice Amount x (VAT Rate / (100 + VAT Rate))
• For 20% VAT: Total Unpaid Amount x (20 / 120) = Total Unpaid Amount / 6

Example:

• You have an unpaid invoice for £2,400 (this is £2,000 net + £400 VAT).
• The amount of VAT to reclaim is £2,400 / 6 = £400.

If the customer made a partial payment, you must apply this to the gross value of the invoice first.

Partial Payment Example:

• Original invoice: £2,400 (inc. VAT).
• Customer paid £600 before disappearing.
• Outstanding balance: £1,800.
• VAT to reclaim: £1,800 / 6 = £300.

Making the Claim on Your VAT Return

This is a common point of confusion. You do not adjust your sales figures or deduct the amount from Box 1 (VAT due on sales) of your VAT return.

Instead, you add the amount of VAT you are reclaiming to Box 4 (VAT reclaimed on purchases and other inputs).

Although it feels counter-intuitive, claiming bad debt relief is treated like reclaiming input tax. You are "reclaiming" VAT you have previously paid over. So, in our example, you would add the £400 of relief to your other input tax for the period and enter the total into Box 4. This will reduce your overall VAT bill or increase your VAT refund for that quarter.

Essential Record-Keeping for Bad Debt Relief

If HMRC decides to inspect your records, you must be able to prove that your claim was valid. Failure to keep adequate records can result in HMRC disallowing the claim and issuing penalties.

You must keep a specific "VAT Bad Debt Relief Account". This can be a separate ledger in your accounting software or a dedicated spreadsheet. For each and every invoice you claim relief on, you must record the following information:

• The date and invoice number of the unpaid supply.
• The name of the customer.
• The total amount of the invoice, including VAT.
• The amount of VAT you are claiming as bad debt relief.
• The VAT period in which you originally accounted for and paid the VAT on the invoice.
• The VAT period in which you are making the bad debt relief claim.

Here is an example of what your bad debt relief record might look like in a simple table:

Invoice Date	Invoice No.	Customer Name	Total Invoice (£)	VAT Claimed (£)	Original VAT Period	Claim VAT Period
15/01/2023	INV-1023	ABC Trading	1,200.00	200.00	Q1 2023	Q4 2023
28/02/2023	INV-1088	Smith & Co.	360.00	60.00	Q1 2023	Q4 2023
10/04/2023	INV-1150	Acme Ltd	2,400.00	400.00	Q2 2023	Q1 2024

These records must be kept for four years.

What Happens if the Customer Pays After You've Claimed?

It's not uncommon for a debt you've written off to be paid months or even years later, perhaps by the customer themselves or by an administrator handling a company's liquidation.

If you receive any payment for an invoice on which you have already claimed bad debt relief, you must repay the relief to HMRC.

You do this by adding the VAT element of the payment received to Box 1 (VAT due on sales) on your next VAT return.

Example:

• You claimed £400 bad debt relief on the unpaid £2,400 invoice to Acme Ltd.
• A year later, Acme Ltd pays the £2,400 in full.
• On the VAT return for the period in which you received the payment, you must add £400 to Box 1.

If you only receive a partial payment, you only repay the VAT element of that part.

• Acme Ltd pays £1,200 of the £2,400 debt.
• The VAT element of this payment is £1,200 / 6 = £200.
• You must add £200 to Box 1 on your next VAT return.

Failing to repay the relief is treated seriously by HMRC.

Common Pitfalls and Special Cases

While the main rules are clear, there are some specific situations that can cause confusion.

The VAT Flat Rate Scheme

If your business uses the VAT Flat Rate Scheme, you cannot claim bad debt relief. The scheme simplifies VAT by allowing you to pay a fixed percentage of your turnover to HMRC. This percentage is set lower than the standard VAT rate and already takes into account the fact that you cannot reclaim input VAT on purchases and that some debts may go bad.

Customer Enters Insolvency

If a customer goes into a formal insolvency procedure (like liquidation or administration), you do not have to wait the full six months to claim bad debt relief. You can make a claim as soon as the debt has been written off in your books, provided you have evidence that the business is formally insolvent (e.g., a letter from the appointed administrator or liquidator). However, if the administrator later pays a dividend to creditors, you will have to repay the corresponding portion of the VAT relief to HMRC.

Preventing Bad Debts in the First Place

While knowing how to claim bad debt relief is a vital safety net, the primary goal should always be to get your invoices paid on time. A robust credit control process is your best defence against bad debts. This includes:

• Clear Terms: Ensure your payment terms are clearly stated on every quote and invoice.
• Prompt Invoicing: Send invoices as soon as the work is complete. Delays send the wrong signal.
• Systematic Chasing: Don't rely on memory. Have a structured process for following up. A friendly reminder before the due date, a polite follow-up the day it becomes overdue, and a series of increasingly firm emails thereafter.

Manually managing this process across multiple clients is time-consuming and prone to error. This is where automating your credit control can be a game-changer. A system like InvoiceReminder connects to your accounting software (like Xero, QuickBooks, Sage, or FreeAgent) and automatically sends out a sequence of polite but persistent email reminders for you. Automating the chase ensures no overdue invoice is forgotten, which can significantly reduce the number of invoices that ever reach the 'bad debt' stage, saving you the time, stress, and administrative burden of having to claim relief.

Frequently asked questions

Can I claim bad debt relief if I'm not VAT registered?

No. This relief is specifically for VAT-registered businesses using the standard accounting scheme. It allows you to reclaim output VAT that you have already paid to HMRC on a sale for which you were never paid. If you are not VAT registered, there is no VAT to reclaim.

I use the VAT Cash Accounting Scheme. Do I need to claim bad debt relief?

No. If you use the Cash Accounting Scheme, you only account for and pay VAT to HMRC when your customer pays you. If an invoice is never paid, you never pay the VAT on it in the first place, so there is nothing to reclaim. This is one of the key cash flow advantages of the scheme for small businesses.

What if my customer goes into liquidation? Do I still have to wait 6 months?

No. If a customer enters a formal insolvency process like administration or liquidation, you do not need to wait the full six months past the due date. You can claim bad debt relief as soon as you have written the debt off in your accounts, provided you can prove the insolvency (e.g., you have received a notification from the appointed insolvency practitioner).

Can I claim relief on the whole unpaid invoice amount?

No. Bad debt relief is only for the VAT portion of the unpaid invoice. The net amount (the value of the goods or services) is written off as a business expense. This write-off will reduce your business's profit, which in turn reduces your Corporation Tax or Income Tax liability. So, you get tax relief on both parts, but through two different tax systems.

How long do I have to make a claim for bad debt relief?

You have four years and six months from the invoice due date to make a claim. This gives you plenty of time, but it's always best practice to claim as soon as you are eligible (i.e., once the debt is six months overdue and written off) to recover the cash for your business.

What happens if I make a mistake on my claim?

If you discover an error (for example, you claimed the wrong amount or later found the invoice had been paid), you should correct it on your next VAT return. For errors under £10,000, you can usually just adjust your next return. For larger errors, you may need to submit a separate disclosure form (VAT652) to HMRC. It's always best to be proactive in correcting mistakes.

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