Do you pay VAT on unpaid invoices?

All businesses pay tax on their profits. Some businesses have to register for VAT as well. In some cases, VAT-registered businesses may have to pay VAT on invoices before they receive payment for them. VAT bad debt relief can, however, allow them to reclaim VAT on unpaid invoices.

The basics of VAT

VAT stands for Value Added Tax. It’s calculated as a percentage of the value of the goods or services. VAT can be applied at different rates for different goods and services. It is, however, applied at a consistent rate across the UK. This means that businesses can choose between simply incorporating VAT into their sales price or breaking it out separately.

As a rule of thumb, businesses that sell mainly to end-consumers tend to incorporate VAT into their prices. Businesses that sell mainly to other businesses tend to break it out separately. This is because VAT is always paid by consumers but can often be reclaimed by VAT-registered businesses.

VAT for businesses

VAT for businesses comes in two forms. These are input VAT and output VAT. Input VAT is the VAT a business pays to its own suppliers. VAT-registered businesses can typically claim this as a tax-deductible expense. Output VAT is the VAT businesses pay to HMRC on behalf of their customers.

If a business is using cash accounting, it will only become liable for tax when it receives income. If, however, a business is using accrual accounting, it becomes liable for tax when the income is recognised. When a business charges businesses by invoice, the date of recognition is the date the invoice was issued, not the due date (or the payment date).

This means that it’s quite common for companies to have to pay VAT on unpaid invoices. It’s particularly likely for companies with higher-value sales. This is because these companies are relatively likely to offer their customers the ability to pay in instalments.

The requirement to pay VAT on unpaid sales invoices shouldn’t create a problem. It does, however, make it even more important that businesses effectively manage their credit control and their accounting. In other words, even though you can reclaim VAT on bad debts, using the HMRC VAT bad debt relief scheme should be your fallback option not your first.

The VAT bad debt relief scheme

The VAT bad debt relief scheme allows businesses to claim back VAT on bad debts. Under current rules, these debts must be a minimum of six months overdue. The VAT bad debt relief time limit is four years and six months after the date payment was due (for supplies made after 30th April 1997).

It’s important to note that the date at which an invoice becomes overdue is based on the invoice due date, not the date on which it was issued. For completeness, if a company does not offer payment terms, then it can be the date on which the supplies were delivered.

As part of the process for reclaiming VAT on bad debts, the company has to move the amount owed out of its day to day VAT accounts and into a separate bad debt account. This is purely an accounting convention. It does not prevent you from taking steps to recover the debt nor does it oblige you to do so.

If you do subsequently recover the debt, then it’s vital that you inform HMRC promptly and pay the VAT you owe.

The importance of credit control

While the HMRC VAT bad debt relief scheme is useful, it is not a substitute for robust credit control. Your aim should always be to have invoices paid on time and in full. This is why it can be very useful to move your customers onto direct debits. Direct debits are a pull-based system, so you are in control of what is collected and when.

We can help

If you’re interested in finding out more about the VAT bad debt relief scheme, then get in touch with our financial experts. Find out how GoCardless can help you with ad hoc payments or recurring payments.