Bad debts can receive tax deductions if they are:
- bad debts that definitely cannot be recovered (eg debtor has already closed down)
- specific bad debts that are doubtful/unlikely to be received
- debts released by the creditor as part of a statutory insolvency arrangement
Bad debts won’t receive tax deductions if they’re general provisions against overall trade debtors. For example, total trade debtors are £10,000 and a general bad provision is created for £1,000.
Specific bad debt provisions
Before the accounts are finalised the trade debtors are normally reviewed for recoverability. If there a debt which is unlikely to be paid then a specific bad debt provision is usually created. For example, Company X Ltd’s debt of £595 is written off.
This reduces trade debtors in the balance sheet and involves a bad debt expense in the P&L.
This bad debt expense will be included in the tax return as an allowable deduction.
The ability of the debtor to pay has to be evaluated as at the year end. So if the debtor only ran into financial difficulties after the year end, then the bad debt expense wouldn’t be allowed as a tax deduction.
HMRC do not consider that a debtor being a slow payer is grounds for a debt being doubtful.
If a debt is written off for reasons other than the debtor facing financial difficulties then HMRC could challenge any tax deduction, for example, if the debtor is related to the business (family connections or parent/subsidiary).
The business should retain evidence supporting a specific bad debt provision such as:
- correspondence with the debtor
- legal letters
- credit reports
- board minutes reviewing aged debtors
If HMRC challenge a bad debt, they would seek to establish the following details about individual bad debts:
- how the extent of its doubtfulness was evaluated, and
- when this was done, and
- by whom, and
- what specific information was used in arriving at that valuation.
S35, S259 Income Tax (Trading and Other Income) Act 2005, S55, S303, S479 Corporation Tax Act 2009