How to claim VAT on Bad Debts

How to claim VAT on Bad Debts

The recent VAT tribunal case of Regency Factors plc provides a salutary lesson on how to claim VAT on Bad Debts under the Bad Debt Relief (BDR) and, perhaps more importantly, how to avoid problems with the claim.

The Upper Tier Tribunal decision (2021 BVC 502) demonstrates how important it is to keep accurate, complete records and to fulfil the obligations contained within the BDR rules.  Regency Factors had appealed against a VAT assessment for £164,932 but found itself having its claim for BDR denied.  The appeal was lost due a complicated accounting system that HMRC considered did not comply with regulations.  Unfortunately for Regency both the First Tier (FTT) and the Upper Tier (UTT) tribunals agreed with HMRC.

The Case

Regency Factors were buying debts from their clients and taking over the collection of those debts. Once the debts were assigned by its clients, Regency could pay an advance which was a % of the debt to be collected less their fee. They kept a running balance of funds available to the clients and fees due, which was represented by the issue of monthly invoices plus VAT. Regency claimed for BDR on fee invoices where it was unable to recover the associated debts…. which actually seems fair enough however, and unfortunately for Regency, it is not that straight forward!

Regency’s accounting system was complicated and HMRC found it difficult to quantify the taxable amount that was unpaid. HMRC disallowed the BDR that Regency had claimed on its VAT Return on the grounds that it had already received consideration for the supplies and therefore no relief fell due.

Regency appealed the assessment, but the FTT agreed with HMRC that there were no bad debts as the point at which the advance to the client was made was the time at which the consideration was received. This was contrary to Regency’s Chief Executive’s assumption that the charges were not paid until collections exceeded the sums of advance payments. The FTT went on to state that the running account balance made it impossible to apportion credits to a particular invoice.

Regency appealed the FTT decision to the UTT and argued that the advance was not always drawn down and that in these cases the invoices had remained unpaid.  Accordingly Regency should be able to claim BDR for these invoices.

The UTT agreed with Regency that the FTT’s decision did not apply to all of the bad debts but concluded that Regency had not maintained a single account of bad debts and therefore the record keeping did not meet the conditions required by regulation.  It followed that HMRC were correct to deny the BDR claim, and Regency lost the case.

How the BDR rules work

The BDR rules are set out in the VAT regulations including the specific record keeping requirements that must be met before any BDR claim can be made.  So how to claim VAT on Bad Debts?  The rules against which Regency’s appeal was tested are summarised below.

Normally a VAT registered organisation can claim BDR against VAT paid to HMRC on unpaid sales invoices. There are certain conditions that must be met before you claim BDR on your VAT return and it is important to know what these rules are.  In order to make a BDR claim you must have:

  1. Already accounted for VAT on the supplies and paid it to HMRC
  2. Written off the debt in your accounts
  3. The value of the supply must not be more than the customary selling price
  4. The debt must not have been paid, sold or factored
  5. The debt must have remained unpaid for 6 months

In support of a BDR claim the regulations stipulate what records need to be kept which are:

  • A copy of the VAT invoices for the supplies on which BDR is being claimed
  • A separate Bad Debt Account showing:
  1. The amount you have written off as a bad debt
  2. The amount of VAT you wish to claim as bad debt relief
  3. The VAT period in which you have claimed a refund
  4. The total amount of VAT charged on each supply
  5. The VAT period in which you originally accounted for VAT on the supply
  6. Any payment received for each supply
  7. The name of your customer, and
  8. The date and number of the invoice to which the bad debt relates (if you did not issue an invoice you must include sufficient information to allow the time and type of the supply to be readily identified)

If you meet all of these conditions then you can reclaim the VAT previously paid over to HMRC by including the VAT on your next return.

Issues highlighted in the case.

This case highlights the importance of identifying the taxable amount and maintaining a Bad Debt account.  The decision addresses the basic principle of the VAT system described in the precedent case of Elida Gibbs Ltd (Case C-317/94). [1997] BVC 80) being that the taxable amount serves as the basis for the VAT to be collected and this cannot exceed the consideration actually paid.

It also addresses the time when a taxable amount is paid and the circumstances in which the taxable amount can be reduced after a supply has taken place.

Written by Catherine Gearing, Tax Technician of AVS VAT originally for the ICPA.  Working for businesses and accountants to stop VAT problems from happening.  Sooner is always betterPlease get in touch with any queries or concerns.

Posted in Relief.