Bad Debts and Tax Relief: What Every Business Needs to Know

Bad debts are more than just a frustrating part of doing business—they can severely damage your cashflow and profitability. And with the average UK business debt now standing at £365,375 per company (according to Swoop Funding’s 2025 report), it’s more important than ever to manage unpaid invoices carefully and understand your rights when it comes to tax relief.

This article walks you through how to write off bad debts, when and how you can claim tax and VAT relief, and what evidence HMRC expects you to have in place.

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What Is a Bad Debt?

A bad debt is money owed to your business that you have little or no chance of recovering. This might be because:

• The customer has gone bankrupt or into liquidation
• You’ve lost all contact with them
• They’ve refused to pay and all recovery attempts have failed

If you’ve already accounted for the income (e.g., raised an invoice and included it in your profit), you could end up paying tax on money you never received—unless you claim relief for the bad debt.

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Who Can Claim Bad Debt Tax Relief?

Only businesses using the accruals basis of accounting can claim bad debt relief. That means:

• You record income when you invoice it, not when you receive payment.
• You record expenses when they are incurred, not when they are paid.

The accruals basis is mandatory for limited companies and self-employed individuals with turnover over £150,000/year.

If you use cash basis accounting (often for smaller sole traders), bad debts aren’t a problem—you don’t count the income until it’s paid, so there’s no need to write it off.

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When Can You Write Off a Bad Debt?

HMRC allows businesses to write off bad debts and deduct them from profits—but only when they become genuinely irrecoverable.

That might be when:

• A liquidator or bankruptcy trustee confirms no payment will be made
• A court has ruled in your favour and the debtor still doesn’t pay
• You’ve tried to collect the debt and it’s clear there’s no realistic chance of payment

Importantly, you must show you made reasonable efforts to recover the money.

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What Counts as “Reasonable Effort”?

HMRC doesn’t require you to chase every penny into the ground—but they do expect some effort, especially for larger debts.

Here’s how you can show due diligence:

For smaller debts (e.g., under £1,000):

• A few reminder emails or letters
• Attempts to call the customer
• Written notice of final demand

For larger debts (e.g., £10,000+):

• Engage a debt collection agency
• Send a Letter Before Action
• Start court proceedings (if commercially viable)

Document every step—you may need this if HMRC asks for proof.

⚠️ Tip: Many debt collection firms won’t take on debts below £600, so consider internal chasing processes for smaller balances.

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When Should You Write Off the Debt?

Ideally, the bad debt should be written off in the same accounting period that the income was originally recognised. That way, you avoid paying tax on the income in the first place.

But if you only realise it’s irrecoverable in a later period, you can still claim the deduction—it just means the relief is delayed.

🧾 Example: You issued an invoice for £5,000 in June 2025 and included it in your 2025/26 profit. In January 2026, the customer goes into liquidation and you write off the invoice. You should deduct the £5,000 as an expense in your 2025/26 accounts.

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How to Account for the Bad Debt

If you’re using accounting software like Xero or QuickBooks, there are usually features to mark an invoice as bad debt. This will:

• Remove it from aged receivables
• Post a debit to bad debt expense
• Reduce your profit accordingly

Your accountant or bookkeeper can help you ensure this is done correctly.

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VAT and Bad Debt Relief (BDR)

If your business is VAT-registered, you may be able to reclaim the VAT you paid on a sale that’s now written off—this is called Bad Debt Relief (BDR).

To claim BDR, the following conditions must be met:

✅ Conditions for claiming VAT Bad Debt Relief:

1. The debt must be over 6 months old from the later of:

• The invoice date, or
• The payment due date
• You must have already accounted for and paid the VAT to HMRC.

1. The debt must be written off in your VAT records and moved to a separate bad debt account.

2. The debt must not have been sold, assigned, or factored to a third party.

3. The value of the supply must not exceed the normal market value.

Once these are satisfied, you can reclaim the VAT on your next VAT return.

🧾 Example: You issued a £6,000 invoice (including £1,000 VAT) in March 2025. The customer never pays, and you write it off in October 2025. By October 2025, six months have passed, so you can reclaim the £1,000 VAT on your next return.

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What Happens If the Customer Pays Later?

If a customer unexpectedly pays the invoice after you’ve written it off and claimed tax/VAT relief:

• You must add the amount back into your income in the year it’s received.
• If VAT was reclaimed, you must repay the VAT on your next VAT return.

This ensures the tax position stays fair and accurate.

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Key Takeaways for Business Owners

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How Merranti Can Help

Bad debts are more than just an annoyance—they can lead to unnecessary tax bills if not handled properly.

At Merranti Accounting, we:

• Help you identify bad debts and write them off correctly
• Ensure you claim all allowable tax and VAT relief
• Guide you on evidence and documentation required by HMRC
• Help you improve your credit control process to reduce future exposure

Whether you’re a limited company, partnership, or self-employed, we’ll make sure your books reflect reality—and your tax bill doesn’t include income you never received.

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Need help writing off a bad debt or reclaiming VAT?
Contact Merranti Accounting today and we’ll guide you through every step.