Whatever accounting method your company uses, its profits have to be calculated on a “true and fair” basis.
That means including the value of invoices issued even where they won’t be paid until the following accounting period – or perhaps not at all. Accounting rules get around this apparent unfairness by allowing a deduction for the value of invoices you think won’t be paid i.e. Bad debts.
Bad debt relief
HMRC allows you to make a deduction from taxable profits for bad debts. However, it takes a tougher approach to it than accounting rules on what is classed as bad debt.
It isn’t just a case of estimating the value of debts you don’t expect to be paid, even if it’s a virtual certainty based on what’s happened historically; you have to carry out a review of each and every specific debt.
Chasing your debts
HMRC will expect you to have made a reasonable and proportioned effort to recover money you are owed.
This will be relevant to the amount of debt of course, e.g. if you are claiming a tax deduction for a £15,000. HMRC expects you to have been very thorough in your attempts to recover it, by using debt collection services for example, or taking court action.
Timing bad debt relief
You should claim relief for the accounting period in which you decide the debt has become irrecoverable.
If you suspect a debt may ‘go bad’, try to establish this in the same accounting period. This ensures that you won’t be taxed on unpaid bills. It is essential that you review your debts regularly – not just when the end of an accounting period is looming!
If the status of a debt you thought was bad at the end of your financial year changes, and before you sign your company’s accounts it is paid, HMRC will not accept a claim for bad debt relief.
This works both ways and if a good debt turns bad you can claim relief. Given this, it is well worth reviewing the debts during this period before signing and filing your accounts.
If you would like to talk about your bad debt situation, we would be delighted to hear from you – we are happy to provide expert advice that is totally free of charge. Simply request a call-back from our website, call on 01902 837 408 or click here to contact Omni Chartered Accounts.