What Is Bad Debt Relief?
Bad Debt Relief

Under standard VAT accounting, you pay HMRC the VAT on an invoice for the period in which the tax point falls, whether or not your customer has paid you. Usually that evens out: the customer pays a few weeks later. When a customer never pays, you have handed HMRC VAT you never received. Bad debt relief is how you get it back. It does not recover the debt itself, only the VAT element, but on a large unpaid invoice that is a meaningful sum.

The rules are set out in section 36 of the VAT Act 1994 and in HMRC's guidance, Relief from VAT on bad debts (VAT Notice 700/18), which this page follows.

The conditions

HMRC lists the conditions you must meet. For supplies made today, the ones that matter are:

HMRC's notice also contains older conditions for supplies made in the 1990s, which do not affect a sale made now.

When you can claim, and the deadline

You must wait at least 6 months from the later of the date payment was due and payable and the date of supply. The due date comes from your normal credit terms or any longer period you agreed with the customer, which is one reason clear payment terms on every invoice matter. You cannot claim on a return for a period earlier than the one in which you become entitled.

For supplies made after 30 April 1997, the claim must be made within 4 years and 6 months of the same later date. Miss that and the relief is lost.

How much you can claim

Your claim is the VAT in the amount still unpaid. On a single supply with no payment at all, it is the VAT you accounted for and paid. If the customer paid part, you can only claim the VAT on the part still outstanding. At the standard rate of 20%, the VAT in a VAT-inclusive amount is one sixth of it, which the VAT calculator works out for you.

Where a customer owes you for several supplies and pays some money without saying what it is for, HMRC's rule is that the payment goes against the earliest supply first. This matters when the supplies had different VAT rates, because it decides which VAT is still unpaid.

A worked example

You invoice a customer £1,200, made up of £1,000 plus £200 VAT, with a supply date of 2 January 2026 and payment due on 1 February 2026. You pay the £200 VAT to HMRC on your VAT Return. The customer pays £480 and then stops responding.

Once you have written off the £720 into a separate bad debt account, and the 6 months have passed, you include £120 in box 4 of the VAT Return covering the date you met the conditions.

Things that reduce the claim

HMRC's guidance sets out a few situations where you claim on less than the full unpaid amount:

• You owe the customer money too. If, when you write off the debt, you owe the debtor something, the claim is on the net figure. HMRC's example is a £720 debt, including £120 VAT, where you owe the debtor £115: relief is claimed on £605, giving £100.83.
• You hold security. If you hold an enforceable security against the debt, you reduce the amount you claim on by the value of that security. A security that cannot be enforced does not reduce it.
• The customer refused only the VAT. If a customer pays the net price but will not pay the VAT, HMRC treats the unpaid amount as the whole debt and allows only the VAT fraction of it: on an unpaid £20 of VAT, that is one sixth, or £3.33.
• Insurance. If you are insured for the VAT-inclusive amount of the debt and the insurer pays you, HMRC says your entitlement to relief is not affected.

How to make the claim

1. Chase the debt properly first. Relief is for debts you cannot collect, not a shortcut. A clear chasing routine, a letter before action and, for business customers, statutory late payment interest come first. The late payment interest calculator and the guide on how to chase an unpaid invoice cover the steps.
2. Write the debt off. Move it from your sales ledger into a separate bad debt account.
3. Wait for the 6 months from the later of the due date and the supply.
4. Work out the VAT in the unpaid amount.
5. Claim it in box 4 of your VAT Return for the period in which you meet all the conditions.

The records you must keep

HMRC says that to support a claim you must keep a copy of the VAT invoice for each supply, or a document showing the same information if you did not issue one, together with records of the amount written off, the VAT claimed and the VAT period you claimed it in. You must also keep the bad debt account itself. HMRC says you must keep these records for 4 years from the date of the claim, which does not change the general rule that VAT records are kept for 6 years.

If the customer pays later

If a customer pays after you have claimed, you must repay HMRC the VAT element of what you receive. HMRC gives the formula: the amount of the claim, multiplied by the payment received, divided by the amount outstanding when you made the claim. The repayment goes in box 1 of the VAT Return for the period in which you receive the payment, and every later payment is recorded in the bad debt account. This applies even if you have since deregistered.

The other side: when you are the customer who has not paid

Bad debt relief has a mirror image. If you are VAT registered and have reclaimed input VAT on a purchase, but you have not paid the supplier within 6 months of the later of the date of supply and the due date, you must repay that input VAT to HMRC. Your supplier does not have to tell you they have claimed relief, so you need to watch your own unpaid bills. If you later pay, you can reclaim the input VAT in proportion to what you pay.

Factoring and assigned debts

If you factor your invoices, bad debt relief depends on the terms. HMRC says relief is not available where the assignment is absolute, meaning the contract has no provision for the debt to be reassigned to you. Where the agreement does allow reassignment, relief becomes available once the debt is reassigned, but not while it remains with the factor. Invoice factoring explains how these arrangements work.

When you do not need bad debt relief

If you use the VAT Cash Accounting Scheme, you only account for VAT on money you actually receive, so an unpaid invoice never generates VAT for you to pay and there is nothing to reclaim. Businesses can join the scheme if their estimated VAT taxable turnover is £1.35 million or less. Some retail schemes work in a similar way. If late-paying customers are a regular problem, cash accounting may suit you better than claiming relief after the event.

Bad debts and income tax

Bad debt relief is a VAT rule, but an unpaid invoice can also affect your income tax. Most sole traders now use cash basis accounting, where income is only counted when it is received, so an invoice that is never paid never became taxable income and there is nothing to deduct. If you use traditional accounting, where income is counted when you invoice, a debt you write off as irrecoverable can reduce your taxable profit for the year. Your VAT claim and your income tax treatment are separate, so record both.

Common mistakes

• Claiming before 6 months have passed from the later of the due date and the supply.
• Not writing the debt off into a separate bad debt account first.
• Claiming the VAT on the full invoice after a part payment.
• Forgetting to repay when a customer eventually pays.
• Missing the 4-year 6-month deadline on old debts.
• Claiming on factored debts that were absolutely assigned.

Related terms

Bad debt relief reverses output VAT you paid on a sale. It sits alongside credit notes, which reduce an invoice when you agree a lower price, and accounts receivable, the ledger where the unpaid invoice sat before it was written off.