Your firm’s financial year ends soon and while the accounts will show a profit you’re expecting them to include significant bad debts. How long will you have to wait to claim a tax deduction for these?

Increased debtors

As a result of coronavirus unpaid invoices are likely to feature more than usual in the accounts of many businesses. While for accounting and tax purposes unpaid invoices count as income, if it becomes clear that they’ll never be paid you can claim a corresponding tax deduction from your profits.

Tip. The rules for claiming bad debt relief for VAT purposes are more clear-cut than those for income and corporation tax. VAT relief can often be claimed sooner.

The uncollectables

As far as unpaid invoices are concerned, the emphasis for determining when a debt is “uncollectable” for accounting purposes differs from that for tax. The accounting rules aim to ensure you don’t overstate profit while the tax rules typically try to prevent you understating them. Consequently, your accountant might reasonably estimate on the basis of experience that a percentage of the debts will not be paid and include a corresponding deduction in your accounts for bad debts. But this won’t necessarily be enough to justify a tax deduction .

Trap. HMRC’s rules don’t accept the accounting principles apply to tax. In theory it requires that you examine each and every debt and only claim a deduction if you have taken appropriate action, e.g. warning letters and even legal action. In practice, however, HMRC is less draconian and may take a softer approach in view of the current financial crisis (so far it has not indicated it will).

In practice

Even HMRC won’t expect you to jump through hoops to recover small debts. If you issue payment reminders and warnings, HMRC will accept that this is enough to warrant a tax deduction. However, for larger amounts you’ll need to do more. For example, using a debt collection service and/or taking court action. There are no rules on what level of action is required to justify a claim but it should be proportionate to the amount of debt.

Tip 1. Set a policy (which you can show HMRC if asked) for your accounts department about the level of action it should take before writing off further attempts to recover a debt. This is bound to be determined by commerciality (you won’t want to give up on a debt unless it’s too costly to pursue) and so should be sufficient to satisfy HMRC.

Tip 2. If a debtor has gone bust HMRC will accept a claim for bad debt relief unless there’s an indication that the liquidator will pay some of it. In that case you can claim a deduction for the debt after deducting the amount you expect to be paid.


You can claim a deduction for the accounting period in which you decide a debt has become irrecoverable. However, if before you approve your accounts the status of debt changes, i.e. you are paid or expect to be paid for an amount currently shown as a bad debt, or vice versa, you should adjust your claim for bad debt relief accordingly.

Before you can claim a deduction for an unpaid invoice you must take steps to recover the debt. Create a realistic policy that sets out the steps your accounts department should take to pursue a debt before giving up. Having followed the policy a deduction can be claimed for debts that remain unpaid at the time you approve your accounts.

Article taken from Tax Essentials for Advisors and reproduced with the permission of Indicator – FL Memo Ltd. For more information visit article is published for information only. It provides only an overview and no action should be taken without consulting the detailed legislation or seeking professional advice. Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the above can be accepted by the author or the firm.