Best ways to write off bad debts

4 min read

Understanding how to have your bad debts written off is important step for small business owners in the UK.

If your business model means you send invoices or extend credit to your customers, knowing when you can write off a bad debt, such as an unpaid invoice, is going to be crucial to your finances.

What is a bad debt?

A bad debt is usually an unpaid invoice, representing an outstanding amount owed to your business that will not be paid.

When a customer fails to pay their invoice, you may reach the point where this bad debt needs to be written off as a loss for compliance and VAT purposes.

However, all unpaid or late invoices are not necessarily classified as bad debts as they may still be settled and are simply late.

When can you write off a bad debt?

Let’s say you’ve been chasing a customer for an unpaid invoice that has been sitting on your accounts receivable ledger for a long time. You may be getting ignored, you may have a refusal to pay, or their business may have closed their doors due to bankruptcy or liquidation.

At what point can you classify and write this off as a bad debt? 

In the UK your limit is six months from the due date. After six months, you can claim your unpaid debt or invoice as a bad debt. 

You must also satisfy several criteria, including evidence of non-payment, the invoice amount and details, and correspondence with the debtor indicating non-payment. 

The HMRC may ask for this proof, so keep records for this eventuality. Online invoicing software or accounting software records can be very useful in this situation.

Is bad debt expense deductible for tax purposes?

Yes, a bad debt is deductible for tax purposes. You can write off this bad debt and classify it as a business expense, as opposed to income.

When it comes to VAT, you may claim back any VAT you’ve already paid the HMRC on this bad debt. Applying for VAT relief due to a bad debt must occur between six months and four years and six months from the due date of the invoice/debt.

Demand letter for unpaid invoices

Before you classify an unpaid invoice as a bad debt and claim it as a business expense and apply for VAT relief, you should make a final attempt at collection through a ‘demand letter’.

This demand letter will contain a reminder of the invoice, the amount due, the date it was due and a warning that you’re readying to write this off as a bad debt.

How to write off a bad debt?

When it becomes clear you have a bad debt on your hands, you need to write this off in your accounts or accounting software – it will no longer be classified as income but as an expense. You can claim the full amount of the debt as an expense, minus VAT.

On your VAT return, you can also claim ‘VAT relief’ on any bad debts for which you’ve already paid the HMRC VAT.

Before claiming VAT relief on bad debts, you must first write it off in your accounts and transfer it to a ‘bad debt account’ which contains:

  • the amount you’ve written off as a bad debt
  • the amount of VAT you wish to claim 
  • the VAT period for which you’re claiming
  • the total amount of VAT charged
  • the VAT period you originally accounted for on the supply
  • any payment received 
  • the name of your customer
  • the date and invoice reference number of the debt in question
  • a copy of any notice or demand letter you issued

It’s always advisable to gain professional advice from your bookkeeper or accountant around bad debts to ensure you undertake this correctly and receive what you’re owed from the HMRC.

Things to remember about writing off bad debts

You should always keep an eye on your accounts receivable to ensure no bad debt goes unnoticed. If you fail to monitor this properly, before signing off your annual accounts, you’ll have paid the HMRC for nothing and be missing out on VAT relief and deductible business expenses.

It’s advisable to tighten your credit control policies if you find you’re encountering a high number of bad debts. You should also consider running credit checks on unknown entities before extending credit.

To help boost payment rates, you should also investigate adopting online invoicing (e-invoicing) solutions. This will encourage early payment and help you monitor your accounts and correspondence easier.

Better yet, inbuilt read receipts and late payment reminders provide hands free payment collection. They’ll also act as proof of correspondence when claiming a bad debt with the HMRC.

This concludes our short guide on bad debts and having your bad debts written off. Keep in mind that the advice of a professional accountant or bookkeeper is indispensable when claiming bad debts. If you require further information on invoicing, please see our full small business invoicing guide.

Free downloadable invoicing template

Our free invoicing template gives you a professional looking layout that you can fill in your company and customer details, and information about the product or service you’re selling. Save time on manual processing, so you can focus on growing your business instead.