If you are a VAT-registered business you must charge VAT when you make taxable supplies. You must also pay over the difference between VAT you have charged and the VAT that you have suffered to HMRC (or, where a scheme such as the flat rate scheme is used, the amount due to HMRC under the scheme rules). Assuming your customers pay their bills, it is the customer who provides the funds for the output tax which must be passed on to HMRC and from which you can recover any input tax that you have incurred.
But what happens if the customer cannot or will not pay their bill?
If you are not paid for supplies of goods or services that you have made to a customer on which you have charged VAT, you may be able to claim relief from VAT on the bad debts that you have incurred. Conversely, if you do not pay bills on which you have reclaimed input VAT, you may need to repay that VAT.
Bad debts
You can claim relief for VAT on bad debts if the following conditions are met.
- You have already accounted for the VAT on the supplies and paid it to HMRC.
- You have written off the bad debt in your day-to-day VAT account and transferred it to a separate bad debt account.
- The value of the supply is not more than the customary selling price.
- The debt has not been paid, sold or factored under a valid legal assignment.
- The debt has remained unpaid for a period of 6 months from the later of the time that the payment was due and payable and the date that the supply was made.
It should be noted that if you use the cash accounting scheme or a retail scheme that allows you to adjust your daily takings for opening and closing debtors, a claim for bad debt relief is unnecessary as VAT is only paid on amounts that you have actually received from your customers.
You must wait at least 6 months from the later of the date on which the payment was due and payable and the date of the supply before making a claim. The claim must be made within 4 years and 6 months from that date. You can claim the relief in your VAT return, but the claim cannot be made in a return for a VAT accounting earlier than the one in which you become entitled to the relief.
The need to wait 6 months before making the claim means that you will have to pay the VAT over to HMRC in the first instance (and meet the cost of this) before claiming it back.
You must also notify your defaulting customer that you have made a claim for bad debt relief.
Repaying input tax
If you do not pay a supplier and you have reclaimed VAT on that supply, you must repay the input tax if the debt remains unpaid 6 months from the later of the date of the supply or date on which the payment was due. If you are given time to pay (for example, payment terms are 30 days), the clock starts from the date payment is due rather than the invoice date.
To make the repayment, you should make a negative entry in your VAT return and account for the repayment in the return for the period in which the repayment became due.
Partner note: VATA 1994, ss. 26A, 36; Value Added Tax Regulations 1995 (SI 1995/2518), Pts. XIX, XIXA, XIXB; VAT Notice 700/18.
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