Bad Debt Relief — Reclaiming Tax and VAT on Invoices You'll Never Be Paid (2026)

The Problem: Paying Tax on Money You Never Got

If you keep your accounts on the accruals basis (also called the standard or traditional basis), you recognise income at the point you invoice — not the point you get paid. The same is true for VAT under standard (accrual) VAT accounting: you account for output VAT on your VAT return for the period in which you raised the invoice, whether or not the customer has paid.

That timing is fine when invoices get paid. But when a customer never pays, you are left out of pocket twice: once for the work and materials, and again because you have already declared that sale for tax and paid the VAT on it to HMRC. Bad debt relief is the mechanism that puts both of those right.

VAT Bad Debt Relief — The Six-Month Rule

If you are VAT registered and on the standard (accrual) VAT scheme, you paid output VAT to HMRC when you issued the invoice. When that invoice goes unpaid you can reclaim that VAT — but only once all of HMRC's conditions are met. The core test is the six-month rule:

• The debt must be at least six months old and more than six months overdue — measured from the later of the date payment was due and the date of supply.
• The debt must have been written off in your VAT accounts and transferred to a separate bad debt account.
• You must not have sold or assigned the debt to a third party (for example, a debt factoring company).
• You must originally have accounted for the VAT on the supply and paid it over to HMRC.
• You did not charge more than the normal selling price for the goods or services.

When those conditions are satisfied, you claim the relief by adding the VAT amount to the figure in Box 4 (VAT reclaimed on purchases) on your VAT return. You do not need to tell HMRC in advance, but you must keep records that prove the debt and the date you wrote it off. There is a time limit: you must make the claim within four years and six months of the later of the payment due date and the date of supply, so do not let old bad debts drift indefinitely.

If the customer later pays all or part of the invoice after you have claimed the relief, you must repay the corresponding VAT to HMRC on your next return. Bad debt relief is a timing adjustment for genuinely unpaid debts, not a permanent write-off you can keep if the money turns up.

Cash Accounting — Why You Will Not Need Bad Debt Relief

If you are on the VAT Cash Accounting Scheme, the whole problem largely disappears. Under cash accounting you only account for output VAT when your customer actually pays you, rather than when you raise the invoice. So if a customer never pays, you never owed HMRC the VAT in the first place — there is nothing to reclaim because you never handed it over.

This is one of the genuine advantages of cash accounting for trades that suffer from late or non-paying customers. The scheme is open to VAT-registered businesses with an annual taxable turnover at or below the qualifying threshold (currently £1.35 million), and you can stay on it until turnover reaches the higher exit threshold. If bad debts are a recurring headache and your turnover sits comfortably within the limits, cash accounting is worth discussing with your accountant — it removes the cash-flow hit of paying VAT on invoices before your customers pay you.

Income Tax and Corporation Tax — Writing Off the Debt

Bad debt relief is not only about VAT. Writing off a genuinely irrecoverable trade debt also reduces your taxable profit, which means a lower income tax bill (for sole traders and partnerships) or a lower corporation tax bill (for limited companies).

This works because, on the accruals basis, you already included that invoice as income in your accounts when you raised it. Writing the debt off creates an allowable expense — a bad debt — that cancels out the income you were taxed on but never received. The net effect is that you are not taxed on money you never got. For the write-off to be allowable, the debt must be a genuine trade debt (money owed for goods or services you supplied in the course of your business) and it must be specifically identified as irrecoverable — a general provision "just in case" is not allowable for tax, only a specific write-off against a named, hopeless debt.

There is an important exception. If you are a sole trader or partnership using the cash basis for your income tax accounts, you only record income when it is actually received. That means a never-paid invoice was never counted as income in the first place — so there is nothing to write off and no further tax relief to claim. You simply never paid tax on that sale. Cash-basis traders get the relief automatically by virtue of how the basis works.

When Is a Debt Actually "Bad"?

A late-paying customer is not the same as a bad debt. A debt is only "bad" when there is genuinely no realistic prospect of recovering it. Before you write anything off you should be able to show that you took reasonable steps to collect the money. Signs that a debt has tipped from merely late into genuinely irrecoverable include:

• The customer's company has been dissolved, gone into liquidation or administration, or a sole trader has been made bankrupt.
• The customer has disappeared — no response to letters, calls or emails, and no contactable address.
• You have pursued the debt through reminders, formal demands or a Letter Before Action and still received nothing.
• The cost and likelihood of recovery (for example, the small claims court route) make further pursuit uneconomic.

HMRC expects you to make a commercial judgement, but it must be a real one. Writing off a debt you have made no effort to collect, or one the customer is clearly willing and able to pay, will not stand up if your records are reviewed.

Chase the Debt First

Bad debt relief should always be your last resort, not your first move. The full value of an invoice in your bank account is worth far more than the partial relief you get by writing it off — you only recover the VAT and the tax on the lost profit, not the whole sum. Before you reach for the write-off, work the debt properly:

• Send a clear, dated reminder as soon as the invoice goes overdue, then a second and a final demand.
• Pick up the phone — a direct conversation resolves more disputes than emails do.
• Consider charging statutory interest and compensation under the Late Payment of Commercial Debts legislation where it applies.
• Issue a formal Letter Before Action setting out that you will pursue the debt through the courts if it is not settled.
• For larger sums, weigh up the small claims (money claim online) route or a debt recovery agency — but remember, if you sell or assign the debt you lose your VAT bad debt relief on it.

Only once you have genuinely exhausted reasonable recovery efforts should you treat the debt as bad and claim the relief.

The Records You Need to Keep

Both the VAT and the income or corporation tax sides of bad debt relief depend on having proper records. If HMRC asks, you need to be able to evidence the original supply, the VAT you accounted for, and the decision to write the debt off. Keep the following for each bad debt:

• A copy of the original VAT invoice showing the date, value and VAT charged.
• The date payment fell due and the date of supply, so the six-month period can be established.
• Evidence that you accounted for and paid the output VAT to HMRC in the relevant return.
• A record showing the debt has been written off in your accounts and moved to a separate bad debt (refunds-for-bad-debts) account.
• Your recovery correspondence — reminders, demands, any Letter Before Action — proving the debt was pursued.
• The amount of VAT reclaimed and the VAT period in which you made the claim.

Keeping clean, dated records of every invoice and every reminder you send makes this straightforward. Good job-management software that logs when an invoice was raised, when it was due, and every chase you sent gives you exactly the audit trail HMRC wants to see — and tells you at a glance which debts have crossed the six-month line.

Quick Reference: Do You Need Bad Debt Relief?

The Bottom Line

An unpaid invoice does not have to cost you twice. If you are on standard VAT accounting, the six-month rule lets you reclaim the VAT you already paid HMRC. If your accounts are on the accruals basis, writing off a genuinely irrecoverable trade debt cuts your income tax or corporation tax bill. And if you are on cash accounting for VAT, or the cash basis for income tax, the system already protects you because you were never taxed on money you did not receive.

The key is to pursue every debt properly first, only write off what is truly bad, claim within the time limits, and keep the records to back it up. Do that, and bad debt relief turns a painful loss into a manageable one. This article is general guidance, not tax advice — check your specific position with your accountant before making a claim.