What is a bad debt?

What a bad debt means

When you invoice a customer, the amount owed sits in your accounts as a debtor, an asset. If it becomes clear the customer will not pay, because they have gone out of business, disappeared or simply refuse, that asset is worthless. Writing it off moves it from the balance sheet into the profit and loss account as a bad debt expense.

A doubtful debt is one you are unsure about. Businesses often make a provision against specific doubtful debts, reducing profit now, while still chasing payment.

Example

A VAT-registered marketing agency invoiced a client £6,000: £5,000 for the work plus £1,000 VAT at 20%. The invoice was due on 15 January. The client entered liquidation in April and the agency is told it will receive nothing.

Step	Effect
Write off the debt	£5,000 bad debt expense reduces profit
Corporation Tax at 19%	Tax saving of £950
VAT bad debt relief (after 15 July)	Reclaim the £1,000 VAT already paid to HMRC

The agency had already paid the £1,000 of VAT to HMRC on its quarterly return. Bad debt relief lets it get that back.

Tax and VAT rules

• Income and Corporation Tax: a specific bad debt that is genuinely irrecoverable is deductible. A general provision, such as 5% of all debtors, is not.
• VAT bad debt relief: you can reclaim the VAT once the debt is more than six months overdue from the later of the due date and the supply date, has been written off in your VAT account, and the claim is made within four years and six months.
• If the customer later pays, the recovered amount is taxable income and you repay the VAT relief.

Why it matters for your business

Bad debts hit cash and profit twice: you have done the work and paid your own costs, and you may have paid tax on income you never received. Credit checks on new customers, deposits, clear payment terms and prompt chasing all reduce the risk. Sole traders on the cash basis never record the income in the first place, so they do not need to write off bad debts for tax.