This is an introduction to the VAT rules relating to bad debts, and the adjustments that debtor and creditor are required to make.

1. Why is the payment late?

There is no provision in VAT Law to provide an explanation why the payment has not been made. The sole condition is that the payment is late.

2. Adjustment of output tax by supplier.

Where an invoice (or invoices) remains unpaid 6 months after the invoice date or due date, whichever is later, an adjustment may be made by the supplier. The adjustment is made by an entry in Box 4 of the relevant VAT Return. VAT previously accounted for is reversed.

3. Adjustment of input tax by customer.

Where an invoice (or invoices) remains unpaid 6 months after the invoice date or due date, whichever is later, an adjustment may be made by the customer. The adjustment is made by a negative entry in Box 4 of the relevant VAT Return. VAT previously claimed is reversed.

4. Supplies at different rates.

When the supply is at the standard rate, the adjustment is 1/6^th of the amount unpaid. When there are supplies at different rates, the claimant is required to apportion the amount of the debt between the different supplies.

5. Margin scheme supplies.

When a supplier has sold goods under the second hand scheme, where output tax is calculated on the profit margin, a claim may be made. But the VAT amount claimed cannot exceed the amount of output tax declared on the original sale.

6. Credit Notes.

You cannot issue a Credit Note to adjust a Bad Debt.

7. Part payment and allocation.

If the customer has made a part payment against a number of debts, the supplier should allocate to the oldest debts first, unless the customer explicitly requests that payments be allocated differently. If there are supplies at different rates of VAT, the adjustment must be calculated accordingly.

8. Subsequent payments.

Where a supplier has claimed VAT bad debt relief, and the customer subsequently pays, then output tax is due on that further payment. In the same way, where the customer makes such a payment, he may re-adjust his input tax accordingly.

9. Factored debts, etc.

Rules relating to factored debts, assignment of debts, and block discounting are covered by different rules. Refer to VAT Manual VATFIN3200 for more information.

10. Cash Accounting scheme.

Where a taxpayer uses the Cash Accounting scheme, he will not account for output tax until payment has been received. Similarly, he will only claim input tax when he makes a payment.

This means that the bad debt rules cannot apply to a person using the Cash Accounting Scheme.

11. Further information.

The Bad Debt rules are found in VAT Regulations 165-172. See also HMRC Notice 700/18, and VAT Manual VBDR1000.