You’re sending your financial records to your accountant so that they can prepare your annual accounts. It’s been a difficult year with many customers paying late or not at all. What steps can you take to ensure a tax deduction for these bad debts?
Outstanding debts
Depending on the type of business you run, the chances are that you frequently have to deal with late-paying customers. Slow payers are bad enough but customers who can’t or don’t pay at all are far more damaging to your business. The small silver lining is that you can claim tax relief for unpaid debts. However, HMRC will only allow relief if conditions are met.
An impaired asset
You might have seen the phrase “impaired asset” in connection with company accounts. It means the value of an asset has permanently reduced. Bad debts are a type of impaired asset which must be shown in your business accounts as an expense so that your profits aren’t overstated. More importantly for you they need to be recorded so that you receive a corresponding tax deduction.
Power tip. Your accountant can’t include a deduction for bad debts if they don’t know they exist. So, keep close tabs on outstanding payments from customers and provide your accountant with a detailed report with your records for your annual accounts.
Conditions for tax relief
Providing a report of debtors to your accountant is just the first step. You, not your accountant, must decide which debts are bad for tax relief purposes. Sometimes it’s clear, e.g. where a customer can’t be contacted despite reasonable attempts to track them down. However, relief can’t be claimed just because a debt is very overdue. Theoretically, HMRC expects you to consider the likelihood of payment for each debt.
Power tip. If your business has a lot of low value debtors, reviewing each one is impractical. There is a solution to this, although it’s often misunderstood, especially by HMRC. You’re allowed to estimate the proportion of debts which are impaired for groups of customers, rather than for each individually. This allows you to claim bad debt relief more easily.
Example – tax relief allowed. Acom has trade and non-trade customers. Its records show that 5% of trade customers and 10% of non-trade customers who owe money for six months or more never pay. Acom can claim relief for bad debts for 5% and 10% of trade and non-trade debts respectively.
Example – no tax relief. Acom Ltd’s accounts show that in earlier years, on average, its bad debts were £10,000. It can’t claim relief by assuming bad debts will be similar for the current year.
Power tip. If you review a specific debt and decide it’s not impaired, you can still include its value when estimating the bad debts for the corresponding group of customers using the principles in our first example.
Good records
Good record keeping is vital for businesses, not least when it comes to claiming bad debt relief. HMRC generally takes a tough approach to bad debt relief; it doesn’t like estimates. However, where you follow our tips it has no grounds to refuse a tax deduction (see Further information ).
Contrary to what HMRC might say, you can use an estimate based on past experience to calculate bad debts that qualify for tax relief, e.g. you know that typically 5% of trade customers who owe you money for more than six months won’t ever pay. Keeping accurate records of debtors will help if HMRC challenges your claim.
Further information
BIM42701 – Specific deductions: bad & doubtful debts: overview