Chris Williams examines what you can do if your business is owed money.
You usually cannot reduce your profits just because the debt has not been paid. The only exception is if HMRC has accepted that you can prepare your accounts on the basis of cash received, which is extremely rare.
But a debt doesn’t have to be completely irrecoverable before you can claim to reduce your profits because it’s unlikely that you will collect it. The law is clear: you can claim relief for debts that are irrecoverable or that you consider to be beyond recovery. This means that it is not only the obvious cases, where you can no longer trace the debtor or the individual has been declared bankrupt or company liquidated, but also any case where you judge that they are unlikely to pay you in full.
Late doesn’t mean doubtful!
Extreme lateness is not enough on its own to establish a debt as doubtful if you expect that it will be paid eventually; you must believe you are unlikely to be paid. This doesn’t mean that there is any sort of objective test to satisfy, only that you genuinely believe that you won’t be paid.
Usually, the judgment you make will be an ‘all-or-nothing’ decision. If you read of a customer’s troubles in the press or by word of mouth from a contact, that may be enough for you to form the opinion that you won’t be paid. That is enough to make an allowable provision in your accounts, so long as your belief is genuine.
How much of the debt do you expect to recover?
Bad debt relief is available to the extent that a debt is considered doubtful or bad, so you may only have to provide for part of the debt. This can happen if, for example, you are already holding a deposit on another order that you can offset against the debt, or if the customer is a company in administration and the administrator has made no offer yet but indicated that he is likely to pay out only 50p in the pound.
You may not have accepted the administrator’s offer, but you can at least provide for half the debt as bad, and if you believe that eventually you won’t receive the other 50% either, you can provide for that as ‘doubtful’.
What if I choose to release a debt I could recover?
A debt that you release does not count as bad unless you agree to the release as part of formal insolvency on the part of the debtor. But you may still be able to reduce your profits for a different reason. If you release the debt for the purpose of the business, the release is still allowable. So if you reason that by releasing one debt, your customer is likely to survive and give you more business in future, it will be allowable; releasing the debt for personal reasons (e.g. one due from a relative or friend) will not be allowable.
Review debts before you finalise your accounts
If you discover that your customer was in financial trouble at the end of your accounting period, you can claim a deduction for the bad debt even if you didn’t know it was bad at the time. What you must do is consider every debt individually; HMRC very rarely accept ‘general provisions’, so keep a record of which debts you reviewed, when and why you think they may go sour.
What if I recover a debt I thought was bad?
You will have to bring that receipt in for the year in which you get paid, but you won’t have to make any adjustment to the earlier year for which you thought the debt was bad.
Practical Tip:
Check up on your late payers. Slowness in paying does not mean you won’t get paid, only that you may not. But if you run a credit check, that may give you reason to treat the debt as doubtful.
