A bad debt is written off when there is no realistic prospect of payment; a doubtful debt is covered by an impairment allowance until the position is clear. For income tax, only bad debts and debts estimated to be bad are deductible under section 35 ITTOIA 2005, while companies get relief for impairment losses under the loan relationship rules. Separately, VAT already paid on an unpaid invoice can be reclaimed through bad debt relief once the debt is six months overdue and written off.

What is the difference between a bad debt and a doubtful debt?

A bad debt is one the business no longer expects to collect at all, for example because the customer has gone into liquidation with nothing for unsecured creditors. A doubtful debt is one where there is evidence that some or all of it may not be paid, but the outcome is not yet known.

Under FRS 102, trade debtors are basic financial instruments. Paragraph 11.21 requires an entity to assess at the end of each reporting period whether there is objective evidence of impairment and, if there is, to recognise an impairment loss in profit or loss immediately. Paragraph 11.22 lists loss events that count as objective evidence, including significant financial difficulty of the debtor, a breach of contract such as a default, a concession granted because of the debtor’s financial difficulty, and it becoming probable that the debtor will enter bankruptcy or other financial reorganisation. Paragraph 11.24 requires individually significant debts to be assessed individually; smaller ones may be assessed individually or in groups with similar credit risk.

How are bad debts recorded in the books?

There are two entries, and they do different jobs. ACCA’s technical guidance describes them as follows.

  • Writing off a debt: debit irrecoverable (bad) debts expense, credit trade receivables. The customer balance is removed from the sales ledger.
  • Allowance for doubtful debts: the allowance reduces the reported value of receivables without removing the individual balance, so collection can continue. Only the increase or decrease in the allowance goes to profit or loss each year.

If a written off debt is later recovered, the receipt is credited back to profit or loss in the period it is received. For timing more generally, see accruals and prepayments.

When can a sole trader or partnership deduct a bad debt for tax?

Section 35 ITTOIA 2005 starts from the rule that no deduction is allowed for a debt owed to the trader. It then allows a deduction only for a bad debt, a debt to the extent it is estimated to be bad, or a debt released wholly and exclusively for the purposes of the trade as part of a statutory insolvency arrangement. Under section 35(2), if the debtor is bankrupt or insolvent, the whole debt is treated as estimated to be bad except to the extent any amount can reasonably be expected to be received.

HMRC’s guidance at BIM42701 adds the practical rules:

  • The deduction is made in the year in which the debt becomes bad or doubtful.
  • The starting point is the amount reserved in the books, provided it is based on a separate valuation of each debt.
  • A general reserve made without regard to the circumstances of the particular debtors should not be admitted.

BIM42710 adds two warnings. Slow payment alone does not make a debt doubtful, particularly where the customer habitually pays late and nothing suggests its finances have changed. And a waiver not based on the debtor’s financial position, for example between relatives or between a parent and subsidiary, may be challenged.

How do companies get relief for bad debts?

For companies the route is different. HMRC’s Corporate Finance Manual (CFM41030) explains that where a debt arises from an unpaid business payment, any impairment loss is dealt with under the loan relationship rules, as is any later reversal of the impairment. Debts that are not money debts fall under section 55 CTA 2009, which allows a deduction only by way of impairment loss or where the debt is released as part of a statutory insolvency arrangement.

Bringing trade debts within the loan relationship regime also brings in its connected party rules. Section 354 CTA 2009 prevents impairment or release debits on a creditor relationship between connected companies where the amortised cost basis under section 349 applies, subject to exceptions such as debt for equity swaps and insolvent creditors. A write off of an unpaid balance owed by a sister company can therefore reduce accounting profit without reducing taxable profit. See connected persons for how connection is tested more broadly.

How does VAT bad debt relief work?

A VAT registered business normally accounts for output VAT when it invoices, so an unpaid invoice means VAT has been paid to HMRC on money never received. Bad debt relief, set out in VAT Notice 700/18 and based on section 36 of the VAT Act 1994 and Part XIX of the VAT Regulations 1995, puts that right. Paragraph 2.2 of the notice requires that:

  • the VAT on the supply has already been accounted for and paid to HMRC;
  • the debt has been written off in the day to day VAT accounts and transferred to a separate bad debt account;
  • the value of the supply is not more than the customary selling price;
  • the debt has not been paid, sold or factored under a valid legal assignment; and
  • the debt has remained unpaid for 6 months after the later of the date payment was due and the date of supply.

The claim must be made within 4 years and 6 months of the later of those two dates (paragraph 2.3), by including the VAT in box 4 of the VAT Return for the period in which the conditions are met (paragraph 2.4). Records, including copies of the invoices and the bad debt account, must be kept for 4 years from the date of the claim. Businesses using the VAT cash accounting scheme only pay VAT on amounts received, so the notice says relief is unnecessary for them.

The customer side mirrors this. Under paragraph 4.1, a business that has reclaimed input tax must repay it if it has not paid the supplier within 6 months of the relevant date.

What does a worked example look like?

Illustration only. A VAT registered sole trader invoices £1,000 plus £200 VAT on 1 March 2026, payable by 31 March 2026. The output VAT is paid to HMRC on the return for that quarter. The customer stops responding and, in September 2026, its director confirms it cannot pay.

Step Treatment
Accounts Write off the £1,200 receivable: £1,000 to bad debts expense, £200 to the VAT account
Income tax £1,000 deductible in the year the debt became bad, as a specific bad debt under section 35
VAT Unpaid 6 months after 31 March 2026, so £200 is claimed in box 4 on the return covering 30 September 2026 or later
Last date to claim 4 years and 6 months after 31 March 2026, which is 30 September 2030

If the customer later pays £600, the trader credits the recovery to profit and, under paragraph 3.14 of the notice, repays the VAT element of the payment by putting it in box 1 of the return for the period in which the payment is received.

What mistakes come up most often?

  • Percentage provisions for income tax. A blanket 5% provision against all debtors is a general reserve, which BIM42701 says should not be admitted. Review debtors one by one.
  • Claiming VAT relief too early. The six month clock runs from the later of the due date and the supply date, not the invoice date alone.
  • Not writing the debt off. Relief requires a separate bad debt account. A note on file is not enough.
  • Claiming on factored debts. A debt that has been sold or factored under a valid legal assignment does not qualify.
  • Forgetting the customer side. Businesses that owe suppliers for more than six months must repay the input tax they reclaimed. This is a common finding in a VAT compliance check.
  • Writing off intercompany balances. Connected company debts are usually outside impairment relief under section 354 CTA 2009.

Errors in past bad debt relief claims are corrected in the same way as other VAT errors; see correcting VAT errors.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.