VAT Bad Debt Relief: How to Reclaim VAT on Unpaid Invoices

If a customer never pays an invoice, you can end up having already paid HMRC the VAT on that sale, even though you never received the money. VAT bad debt relief exists to put that right, and HMRC’s own guidance on the rules is set out in VAT Notice 700/18.

Why bad debt relief exists

Under standard VAT accounting, VAT is normally due to HMRC based on when you issue an invoice (or the tax point is created), not when you’re actually paid. If a customer then fails to pay, you’ve already handed over VAT on income you never received. Bad debt relief lets you reclaim that VAT back.

Conditions for claiming

To claim VAT bad debt relief, all of the following must apply:

• The VAT has already been paid to HMRC on the original invoice
• The debt is at least 6 months overdue, counted from the later of the payment due date or the date of supply
• You’ve written off the debt in your accounting records as bad
• The claim is made within 4 years and 6 months of the payment due date (or supply date, if later)

Miss the time limit and the relief is lost, so it’s worth reviewing aged debts regularly rather than leaving a bad debt claim until close to the deadline. Reclaiming the VAT element of an unpaid invoice as soon as the debt qualifies also helps cash flow, rather than leaving money tied up with HMRC on income that may never arrive.

How to claim it

Unlike some reliefs, there’s no separate claim form. VAT bad debt relief is claimed by simply adding the VAT amount to Box 4 of your VAT return for whichever VAT period you’re in when the debt first qualifies, the box normally used for input tax, HMRC’s term for the input VAT you’re reclaiming on purchases, as set out in GOV.UK’s guidance on relief from VAT on bad debts. The relief applies in the same way regardless of whether the original supply was of goods or services, provided VAT was correctly charged for VAT purposes on the original invoice. Alongside this:

• You must have written off the debt in your accounts as bad
• You’re required to notify the customer in writing that you’ve claimed relief on the unpaid VAT, this doesn’t affect their own liability to you for the debt, but it’s a formal requirement of the claim

Keep the paperwork, the original invoice, evidence of the debt being overdue, and the write-off, in case HMRC asks to see it. HMRC also expects claims to be tracked in a separate bad debt account within your VAT records, showing the date and amount of each write-off and the VAT reclaimed, rather than the claim simply appearing as an adjustment on the return with nothing behind it.

What happens if the customer later pays

If a customer eventually pays a debt you’ve already claimed bad debt relief on, you need to repay the VAT you reclaimed, by including it as output VAT (Box 1) on the return covering the period the payment was received. Bad debt relief isn’t a permanent write-off of the VAT liability if the money does eventually come in.

The Cash Accounting Scheme exception

If your business uses the Cash Accounting Scheme, VAT bad debt relief generally isn’t needed. Under cash accounting, you only account for VAT once your customer has actually paid you, so if they never pay, you never had to hand over that VAT to HMRC in the first place, there’s nothing to reclaim.

This is one of the practical reasons some businesses with a history of slow-paying customers choose cash accounting over standard invoice accounting, it avoids the bad debt problem at source, rather than needing to reclaim relief after the fact. Which approach suits a business better usually comes down to how reliably customers pay and how much VAT-registered purchasing the business does, since the Cash Accounting Scheme also affects when input VAT on your own purchases can be reclaimed, not just output VAT on sales.

Reviewing unpaid invoices

Bad debt relief is easy to overlook when a customer simply goes quiet rather than formally disputing an invoice. If your business has unpaid invoices sitting on the books past 6 months, it’s worth checking whether a claim is available before the 4-year-6-month window closes. This applies to a business that’s still VAT registered, but the entitlement comes from the original supply, so a debt from your time as a VAT-registered business isn’t automatically lost purely because the business has since deregistered, though claiming outside a live registration follows the VAT regulations on post-deregistration claims rather than the normal Box 4 process. The amount of VAT involved on a single large unpaid invoice can be significant enough on its own to justify reviewing your aged debtor list every quarter rather than waiting until year-end. Our VAT Returns service reviews aged debts as part of preparing your quarterly return, so relief you’re entitled to isn’t missed.