The Invoice That Never Gets Paid
Every business that gives customers time to pay will eventually meet one who doesn't. The customer goes into administration. The dispute drags on until nobody remembers what it was about. The director stops answering the phone.
At some point you have to stop treating that invoice as money you are about to receive. That is a bad debt: an amount a customer owes you that you no longer expect to collect.
Getting the accounting right matters for three reasons. Your profit is overstated until you deal with it. Your balance sheet shows an asset that does not exist. And there is tax and VAT to claw back, which a lot of small businesses never do.
This guide covers the difference between bad and doubtful debts, how to write one off, how a provision works, the journals, a worked example, and the tax and VAT rules. It finishes with what we actually think about bad debts after years of looking at other people's sales ledgers.
Bad Debts vs Doubtful Debts
The two terms get used interchangeably. They are not the same thing.
- A bad debt is one you are satisfied will not be paid. The customer is in liquidation with nothing left for unsecured creditors, or you have decided that chasing it further would cost more than it is worth. You write it off, which removes it from trade receivables completely.
- A doubtful debt is one that might not be paid. It is overdue, the customer is wobbling, or there is a dispute. You haven't given up, so you leave the invoice in the sales ledger and set up a provision (also called an allowance or an impairment) against it.
Accountants and exam papers also use the phrase irrecoverable debts, which means the same as bad debts. ACCA uses it in its syllabus, so students tend to see that term first.
The practical difference is reversibility. A provision is an estimate you revisit every period. A write off is a decision. If money turns up after a write off, it is treated as a recovery, which we cover below.
How to Write Off a Bad Debt
The write off itself is a simple double entry. You reduce the amount owed by the customer and charge the loss to the profit and loss account.
Say a customer owes you £6,000, made up of £5,000 for the work and £1,000 of VAT. You are VAT registered on standard accounting, so you have already paid that £1,000 to HMRC.
Step 1: write off the debt.
| Debit | Credit | |
|---|---|---|
| Bad debts (profit and loss) | £6,000 | |
| Trade debtors (balance sheet) | £6,000 |
Step 2: once the VAT bad debt relief conditions are met, reclaim the VAT.
| Debit | Credit | |
|---|---|---|
| VAT control account | £1,000 | |
| Bad debts (profit and loss) | £1,000 |
The net cost in the P&L is £5,000, which is what you actually lost. The VAT comes back separately, and the timing rules for that are further down.
If you use Xero or similar software, check how it handles write offs before you click anything. Many people clear bad debts by raising a credit note. That works for the ledger, but if the credit note carries VAT, your software will reduce your output tax straight away, before you are entitled to the relief. It is also a document that says the customer no longer owes you anything, which is not a great thing to have on file if you later decide to sue. Code the credit note with no VAT, keep it internal, and claim the VAT through the proper route when the time comes.
For the underlying mechanics, our guide to double entry bookkeeping walks through how debits and credits work.
The Provision for Doubtful Debts
A provision deals with debts that are at risk but not yet dead. Instead of touching the customer's balance, you set up a separate account that sits against trade debtors on the balance sheet.
To create or increase a provision:
| Debit | Credit | |
|---|---|---|
| Bad debts (profit and loss) | £4,000 | |
| Provision for doubtful debts (balance sheet) | £4,000 |
Trade debtors are then shown net of the provision. The customer's account in the sales ledger stays exactly as it was, so your credit control team keeps chasing it.
Each year end you work out the provision you need and post only the movement. If last year's provision was £4,000 and this year you need £2,500, you release £1,500 back to the P&L as a credit. That release is why a business can sometimes show a negative bad debt charge in a good year.
Specific and General Provisions
There are two ways of building the number.
- A specific provision is made against named invoices, customer by customer. "Harlow Fit Out Ltd owes £4,800, they dispute half of it, and they are 120 days late. We provide against it."
- A general provision is a percentage applied across the ledger, usually by age. For example, nothing on current invoices, 2% on 31 to 60 days, 10% on 61 to 90 days, 50% on anything older.
Under FRS 102 Section 11, which most UK private companies follow, you provide where there is objective evidence that a debt is impaired. Customers going into insolvency, breaching payment terms or being in significant financial difficulty are the examples the standard gives. Listed groups on IFRS 9 use a forward-looking expected credit loss model instead, which usually means a provision matrix built from past loss rates. Micro entities on FRS 105 follow a simpler version of the FRS 102 approach.
The tax treatment of the two types is different, and that is where most small business problems start.
Bad Debts and Tax
Corporation Tax and Income Tax
For a limited company, section 55 of the Corporation Tax Act 2009 says no deduction is allowed for a trade debt except so far as the debt is bad, estimated to be bad, or released as part of a formal insolvency arrangement. The same rule for sole traders and partnerships using traditional accounting sits in section 35 of the Income Tax (Trading and Other Income) Act 2005.
In practice that means:
- Specific write offs are deductible.
- Specific provisions against identified debts are deductible, as long as the estimate is reasonable and you can show your working.
- General provisions built from a flat percentage are normally not deductible. They are added back in the corporation tax computation and only get relief later, when individual debts are specifically written off or provided for.
HMRC's Business Income Manual covers this from BIM42701 onwards. The theme running through it is evidence. A note in the file saying which customer, how much, how old, what you did to chase it and why you think it will not be paid is worth more than any formula.
Sole Traders on the Cash Basis
Since 2024/25 the cash basis has been the default for sole traders and partnerships. On the cash basis you only record income when you are paid, so an unpaid invoice was never income in the first place. There is nothing to write off and no deduction to claim. If you have opted out of the cash basis, the normal rules above apply.
VAT Bad Debt Relief
If you are on standard VAT accounting, you pay VAT to HMRC based on invoices issued, not money received. When a customer never pays, you have handed HMRC VAT you never collected. Bad debt relief gets it back.
HMRC's rules are in VAT Notice 700/18. The conditions that matter for most businesses are:
- You have already accounted for and paid the VAT on the supply.
- You have written the debt off in your accounts and moved it to a separate bad debt account.
- The debt has been unpaid for six months after the later of the date payment was due and the date of the supply.
- You have not sold or factored the debt.
- You claim within four years and six months of the later of those two dates.
You claim by including the VAT in box 4 of your VAT return, the same box as input tax. You do not need to tell the customer. They are required, on their side, to repay any input tax they claimed on an invoice they haven't paid within six months.
If the customer later pays some or all of the debt, you repay the matching VAT through box 1 of the return for the period you receive the money.
Two points we see missed regularly:
- You do not need to wait for the customer to go bust. Six months overdue and written off in your books is enough. A debt that is still being chased through the small claims court can qualify, as long as you have written it off in the accounts.
- Businesses on the cash accounting scheme cannot claim, because they never paid the VAT on the unpaid invoice in the first place. That is one reason cash accounting suits businesses with slow or unreliable customers. The VAT flat rate scheme has its own adjustment, so get advice before claiming.
A Worked Example
Brookfield Joinery Ltd is a fit out contractor in Enfield with a 31 December year end. It is VAT registered on standard accounting and its taxable profit falls in the marginal relief band, so its effective marginal rate of corporation tax is 26.5%.
At 31 December 2026 its sales ledger shows £148,000 owed by customers. Going through the aged debtors report with the director, three things come up.
1. A customer in administration. Kestrel Developments Ltd owes £14,400 (£12,000 plus £2,400 VAT) on an invoice dated 15 May 2026, due on 14 June. The administrators have said unsecured creditors should expect nothing. This is a bad debt, so it is written off in full.
The six month period for VAT runs from the due date, 14 June, so the debt qualifies for relief from 15 December 2026. Brookfield can claim the £2,400 in its October to December VAT return. The net P&L cost is £12,000.
2. A disputed invoice. Harlow Fit Out Ltd owes £4,800 (£4,000 plus VAT), now 120 days overdue. They say part of the work was defective. Brookfield is still pursuing it but doubts it will get paid. A specific provision is made for £4,000. We provide for the net figure because if the debt does go bad, the £800 of VAT will come back through bad debt relief.
3. Everything else. The director wants a general provision of £2,000 across the rest of the ledger as a cushion.
| Charge to P&L | Deductible for CT? | CT effect at 26.5% | |
|---|---|---|---|
| Kestrel write off (net of VAT relief) | £12,000 | Yes | £3,180 saved |
| Harlow specific provision | £4,000 | Yes | £1,060 saved |
| General provision | £2,000 | No, added back | £0 now |
| Total | £18,000 | £16,000 | £4,240 saved |
The general provision still reduces Brookfield's accounting profit, which affects its retained earnings, but it gives no tax relief this year. If one of those customers does go bad next year, the relief arrives then.
The VAT relief of £2,400 is different. It is cash back from HMRC, not just a lower tax bill, and it only arrives if someone remembers to claim it.
When a Written Off Debt Gets Paid
It does happen. A liquidator pays a small dividend to creditors, or a customer who vanished reappears wanting to trade with you again.
When money arrives on a debt you have written off, you record it as income, often in an account called bad debts recovered.
| Debit | Credit | |
|---|---|---|
| Bank | £1,200 | |
| Bad debts recovered (profit and loss) | £1,200 |
It is taxable in the period you receive it. If you claimed VAT bad debt relief on the original invoice, you also repay the VAT fraction of what you received through box 1 of your VAT return. On a £1,200 receipt against a standard rated invoice, that is £200.
If you receive a distribution from a liquidation, you will usually have had to submit a proof of debt to the insolvency practitioner first. It is worth doing even for small amounts, because the paperwork also backs up your tax and VAT position.
Before You Write It Off: Getting Paid
A write off should be the last step, not the first. Before you get there, UK law gives you more leverage than most small businesses use.
- Statutory late payment interest. On business to business invoices, the Late Payment of Commercial Debts (Interest) Act 1998 lets you charge interest at 8% above the Bank of England base rate, plus fixed compensation of £40, £70 or £100 depending on the size of the debt. Mentioning it in a chaser letter often gets things moving.
- The small claims track. For debts up to £10,000 in England and Wales, you can issue a claim online through Money Claim Online. It costs less than most people expect, and a County Court Judgment affects the customer's credit rating.
- A statutory demand. Where a limited company owes you more than £750 and the debt is not genuinely disputed, a statutory demand can lead to a winding up petition. It is a serious step, but it gets a director's attention quickly.
- A debt collection agency that works on a percentage of what it recovers.
Weigh the cost against the size of the debt, and remember that time spent chasing is also a cost. Our guide to cash flow forecasting covers how to plan around slow payers so a single one cannot sink the month.
Our View
Most bad debts are a credit control problem, not bad luck. When we look back at a written off invoice, there was nearly always a warning sign months earlier: a customer who started paying later and later, a credit limit nobody enforced, work that carried on while old invoices sat unpaid. A weekly look at the aged debtors report, paired with a rule that you stop work once a customer is 30 days over terms, prevents most of the losses we see. Trade receivables and debtor days are the numbers to watch.
Dead invoices on the balance sheet cause real damage. An unpaid invoice from two years ago that nobody has written off inflates profit, inflates working capital and makes the current ratio look better than it is. It can also mean a company pays a dividend out of profits that do not exist. Under the Companies Act 2006, a dividend paid without enough distributable reserves is unlawful, and directors can be personally liable to repay it. If a debt is dead, write it off before you work out what you can take out of the business.
Claim the VAT. It is your money. VAT bad debt relief is one of the few reliefs that is genuinely mechanical: six months, written off, box 4. Yet it is one of the most commonly missed items when we take on a new client. Businesses doing their own VAT returns often do not know it exists. With a four and a half year window, there may be several years of claims sitting there.
Keep the general provision small and honest. Some directors like a large general provision as a buffer against a bad year. It gives no tax relief until the debts are identified, and it makes it harder to see which customers are actually a problem. We prefer a specific review, line by line, with a short note on each doubtful debt. It takes 30 minutes at the year end, and the tax treatment follows naturally.
Check a new customer before you give them credit. Look them up on Companies House. Are their accounts overdue? Is there a first Gazette notice against them? Have they filed micro entity accounts showing net liabilities? Five minutes of checking would have prevented a fair share of the bad debts we have written off for clients. For bigger contracts, a deposit or stage payments do even more.
How IAK Can Help
We deal with bad debts at every stage, from setting up credit control so they do not happen, to writing them off properly and recovering the tax and VAT when they do.
Our bookkeeping team keeps the sales ledger reconciled and flags customers who are drifting past terms. Our management reporting service includes a monthly aged debtors review, so problems show up while there is still time to act. Our accounting team prepares year end provisions under FRS 102 and FRS 105 with the working papers HMRC expects, and our VAT advice team reviews old debts for bad debt relief claims going back up to four and a half years.
We work with small businesses, limited companies and construction companies, where long payment terms and disputed final accounts make bad debts a regular issue. If you are sitting on old invoices you are not sure what to do with, get in touch for a free consultation.
Sources
- Relief from VAT on bad debts (VAT Notice 700/18), HMRC, sections 2.2 to 2.4 on the conditions, time limit and box 4 claim, section 3.14 on repaying relief when payment is received, and section 4.1 on the customer's obligation to repay input tax.
- Corporation Tax Act 2009, section 55, legislation.gov.uk, on the restriction of deductions for bad and doubtful debts.
- Income Tax (Trading and Other Income) Act 2005, section 35, legislation.gov.uk, on the equivalent rule for unincorporated businesses.
- Business Income Manual BIM42701, HMRC, on HMRC's approach to bad and doubtful debts.
- FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, Financial Reporting Council, Section 11 on the impairment of basic financial instruments.
- Late commercial payments: charging interest and debt recovery, GOV.UK, on statutory interest and fixed compensation.
- Make a court claim for money, GOV.UK, on Money Claim Online and the small claims track.