Andrew Needham looks at claiming VAT bad debt relief and highlights some points to look out for.
The basics of claiming bad debt relief (BDR) is that when an invoice has remained unpaid, or partly unpaid, for six months after the due date for payment, it is possible to claim BDR on the outstanding amount from HMRC on the VAT return covering the period when the BDR becomes claimable. If the debt is eventually paid then you have to pay the VAT back to HMRC on your next VAT return.
However, there can be some twists to claiming BDR that businesses should be aware of, to make sure they get the full amount and also don’t fall foul of HMRC.
VAT only invoices
Some businesses may raise ‘VAT only’ invoices from time to time, for example, when you have failed to charge VAT in error, or when you are dealing with insurance work for a VAT registered business.
Example 1: ‘VAT only’ invoice
ABC Garages does accident repair work for insurance companies. The customer is VAT registered and can claim the VAT back on the repairs to one of its commercial vehicles. The insurance company pays £2,000 for the repairs and a VAT invoice is sent to the customer showing the net amount has been paid but the VAT amount of £400 is outstanding. All the customer has to pay is the VAT amount of £400, which he can reclaim from HMRC.
Let’s say the customer goes into liquidation and does not pay the outstanding VAT. What amount should be claimed as BDR? At first sight, it would appear to be the £400 on the ‘VAT only’ invoice as the whole amount is VAT.
In the case of Simpson & Marwick v HMRC [2013] CSIH 29, which was finally settled in the Court of Session in 2013, the court decided that, in effect, the BDR reclaimable would not be the full £400 in our example. The total bill was £2,400 (i.e. £2,000 for the repairs and £400 for the VAT). ABC Garages had been paid £2,000 and £400 was outstanding. The BDR claimable was therefore only £66.66 (£400/6).
Flat rate scheme
There is a welcome loophole in the flat rate scheme for small businesses (FRS) that allows a small benefit when using the cash basis.
Under the cash basis of the FRS, the scheme percentage only has to be accounted for when the customers pays; therefore, you might think that bad debt relief would automatically be accounted for, because if you haven’t been paid you haven’t paid HMRC the flat rate percentage.
However, if you use the cash basis of accounting you may be eligible for bad debt relief if:
- the debt has been due six months from the date you made the supplies;
- you have not accounted for and paid tax on the supply; and
- you have written off the debt in your VAT BDR account.
If you meet all these conditions, your claim will be for the difference between the VAT you charged to your customer and the amount you would have declared to HMRC had you been paid. This is because the flat rate takes account of input tax that would otherwise have been claimed if you had been paid by your customer.
Example: Flat rate scheme
Let’s assume that you issue an invoice for £1,000 plus £200 VAT (total £1,200). The flat rate percentage is 10% so you pay HMRC £120.
The difference between what you should have paid HMRC and what your customer owes you is £80 (£200 - £120) so you can claim £80 from HMRC.
Practical Tip:
If you claim BDR, make sure you understand how the system works. If you are on the cash basis of the FRS, you may be in for an unexpected windfall.
