Lee Sharpe looks at provisions for bad debts and when they should be allowed for tax purposes.
There is an old saying that goes broadly: ‘When you owe the bank £1,000 and you cannot pay, you’ve got a problem; when you owe the bank £1 million and cannot pay, the bank has a problem’.
This article looks at the approach to bad debts and particularly doubtful debts, as is commonly termed ‘provision for bad and doubtful debts’. In particular, why HMRC might disagree with the timing of a corresponding tax claim.
Provision for bad and doubtful debts
Accounting purists may be grinding their teeth at this common description because, strictly:
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one does not ‘provide for’ the reduction of an asset, such as a debt to one’s business (the correct description is ‘impairment’ of an asset); and
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neither does one ‘provide for’ a bad debt; either it is ‘bad’ (irrecoverable), or it is not.
So, please feel free to embark on the good ship ‘SS Debt Impairment Review’, if that works for you (although the destination is likely the same).
Essentially, we are talking about the exercise that is undertaken by those in business to gauge the likelihood (or otherwise) that all of their debts will be paid, and in full. It may be art as much as science, but we all do it. Where the debt is known to be irrecoverable – such as because the debtor has gone into liquidation and ordinary creditors are not expected to get a payout – then we would call it a bad debt. Where there is a chance of full or partial payment, then we are more in the realms of a doubtful debt, and there is typically an element of judgement required as to likely recovery.
Now clearly, you should not be paying tax on income that you will never receive; but here, HMRC is likely to want you to be able to prove it is not recoverable – almost ‘never say never’.
Generally accepted accounting practice
The tax code broadly states that tax follows accounting profits derived according to generally accepted accounting practice (GAAP), except where the legislation requires otherwise.
However, in relation to bad or doubtful debts, the legislation goes on to state that tax relief is allowed only to the extent that the debt is in fact bad, or is estimated to be bad (ITTOIA 2005 s 35; for companies, an impairment review of the debt is required).
It follows that a simple general provision of x% of one’s total debtor balance at year-end is not deductible for tax purposes – see HMRC’s Business Income Manual at BIM42701. Even so, this does not prevent relief for a reasonable provision, after having undertaken a debt-by-debt review of the ledger, then to build up a comprehensive aggregate provision (impairment). In other words, a sufficiently scientific and detailed approach to evaluating the likely recovery of one’s debts, in accordance with GAAP, can derive a provision for doubtful debts that is tax-allowable.
HMRC rushes in…
Long experience tells me that the average tax inspector’s appreciation of GAAP is…not ideal. In terms of tax cases, a likely forerunner will be the series culminating in HMRC v NCL Investments Limited and another [2022] UKSC9. But my personal favourite is William Grant & Sons and Mars UK Ltd v HMRC [2007] UKHL 15.
NCL Investments oriented around glamorous share options, while William Grant involved whisky, chocolate bars and everyday depreciation (which reads like weekend goals for, say, a tax writer pushing the wrong side of fifty!). HMRC is undoubtedly the villain in Grant, seeking permission to carry on disallowing depreciation that hadn’t even been taken to the company’s profit and loss account. But the recent case Accelerate Corporation Ltd v HMRC [2025] UKFTT 00419 (TC) (‘Accelerate’) went decidedly in HMRC’s favour.
Accelerate Corporation Ltd
The Accelerate case involved a trading company (AC) that had made sales of many hundreds of thousands of pounds to a client in its year to 30 September 2016, and then sought to claim bad debt relief for around £300,000, on amounts that its director expected not to be paid. This was not a general provision by the company but a claim to relief for specific amounts, against a specific debtor, that had not been paid.
The case hung on when the company’s director could reasonably argue that he thought the debt had turned doubtful, or likely irrecoverable. He was quite loose on when that relief should arise – being happy with either the year to 30 September 2016 (as initially claimed), or the following year to 30 September 2017 (so the net loss could then be carried back against the company’s 2016 profits, under CTA 2010, s 37). HMRC wanted to allow the relief in the next period: the 18 months to 31 March 2019.
The First-tier Tribunal considered that there was little historic evidence to support that AC had considered that its debt would be irrecoverable at any point running up to 30 September 2017:
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AC had not filed its own tax return (as might have evidenced a write-off) with HMRC for the year to September 2016 (and had not filed a return since).
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The debtor client had ceased trading in 2018 (being a common trigger for when outstanding debts might be considered at least partly irrecoverable or ‘doubtful’); a striking-off action was soon posted in May 2018, hence HMRC was inclined to accept that the debt’s recoverability was in doubt, absent any strong evidence pointing to another date.
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Even as late as 2022, AC’s director had told HMRC that he expected at least some of the debt would be recoverable.
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AC had taken no formal action to pursue the debt – engaging solicitors, etc.
The judge upheld HMRC’s approach that the debt should not be treated as irrecoverable until as late as the (long) accounting period ended 31 March 2019. Given the above, it is perfectly understandable. But I do have some sympathy for AC’s director, who had explained:
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where AC’s likely debt recovery was reliant on a business angel investing in the company’s stricken client, far from simply ‘throwing good money after bad’, his continuing to assist the client with its projects could be justified, as it made the client more likely to be saved; and
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in a similar vein, he had deliberately refrained from commencing creditor action against the client, for fear of scaring away potential investors and torpedoing any hopes of recovery.
I suspect the judge would have been more inclined to follow such arguments if they had been supported by contemporaneous evidence.
Conclusion
I think that many of the claimant company’s problems will stem from its being beholden to this one major client. But the appellant company in this case did not help itself. Its accounts and records were far from ideal – for example, the director had not even included those sales to that client in the company accounts in the first place – arguing that the company was “practically on a cash basis”. As the judge made quite clear, no company can apply the cash basis; GAAP is a company’s only option.
Note also that, while the director was saying as late as 2022 that he hoped some of the debt might be recoverable, there was no evidence his company had deliberated over how much might be recoverable, at its balance sheet dates of 30 September 2016, then 30 September 2017, 31 March 2019, etc. Would HMRC (and the tribunal) have been more amenable if it could have seen the anticipated recoverable amount getting eaten away in chunks, over the years? Surely this unhappy turn of events could have been avoided if the company had taken appropriate professional advice at the time on how to deal with this very large and risky debtor.
As an aside, perhaps the key saving grace for the cash basis for income tax (as applies to non-corporates) is that you can ignore bad and doubtful debts, since you have to count income only when it is actually received (I generally do not recommend the cash basis for non-corporates, but even I can see that a business in circumstances like AC’s would have found the cash basis a great help – where available).
