1 Value-Added Tax Information Leaflet BAD DEBTS (excluding hire-purchase) 1. General Bad debt relief arises when a customer defaults in full or part on payment to a supplier where that supplier has accounted for VAT in respect of the supply. The conditions under which bad debt relief is allowed are set out in Section 10(3)(c) of the VAT Act and regulations 8(1)(m) and 16A of the VAT Regulations, 2006 (as amended). 2. Purpose of this leaflet The purpose of this leaflet is to explain the VAT relief available for bad debts written off, the conditions to be satisfied and how the relief should be calculated and claimed. 3. What debts are covered by the relief? For business purposes, a debt is regarded as bad when the decision has been made that it is irrecoverable. This decision is usually arrived at when all reasonable efforts have been made, without success, to collect the debt in question and the supplier is in a position to reduce the amount of debts in his/her accounting records by the amount of the debts regarded as bad. The expiry of the supplier s trade credit period is not, on its own, sufficient to trigger an entitlement to bad debt relief. In general, an accountable person who has accounted for VAT on a supply (other than to a connected person) may claim relief for the VAT attributable to the supply where he/she is in a position to demonstrate that: He/she has taken all reasonable steps to recover the bad debt. The bad debt is allowable as a deduction in arriving at the tax-adjusted profits for income tax or corporation tax. The bad debt has been written off in the financial accounts of the accountable person and the obligation to keep relevant records in relation to the debt have been fulfilled (see paragraph 6). The person from whom the debt is due is not connected to the accountable person (see Appendix 1)
2 The VAT bad debt relief should be calculated in accordance with the VAT analysis of the transactions outlined in paragraph 10 below. Bad debt relief is available only to traders who account for VAT on the invoice basis. Bad debt relief is available only for bad debts actually written off and is not available in respect of specific or general provisions for bad or doubtful debts 4. What are reasonable steps? Reasonable steps will depend on the facts and circumstances of each case and can comprise a number of actions undertaken to recover the debt, including correspondence with the debtor, referral of the issue to a solicitor or a debt collection agency or other action undertaken, resulting in objective evidence that the trader is in a position to reasonably consider that the debt is bad and to reduce the amount of debts in his/her accounting records by the amount of the debts regarded as bad. Correspondence from a liquidator stating that there are no funds to pay nonpreferential creditors would constitute such evidence and would justify the writing off of a debt. A trader is required to retain evidence of action taken, including all correspondence, in attempting to recover the debt. 5.What does written off as a bad debt in the Financial Accounts mean? The bad debt must be written off in the day-to-day records of the business and transferred from the debtors account to a separate bad debts account. A trader is not required to wait until his financial year-end to write off a debt but may do so in the VAT return for the taxable period in which the debt is transferred to the bad debt account. 6. Obligations in relation to record keeping A trader s records of all transactions in relation to bad debts written off must include particulars of the name and address of the debtor, the nature of the goods or services to which the debt relates, the date or dates on which the debt was incurred, and the date or dates on which the debt was written off. 2
3 A trader seeking bad debt relief is required to keep copies of the relevant VAT invoices and evidence that the VAT had been accounted for. All records relating to bad debts written off must be kept for 6 years from the date of the write off. 7. Unpaid debts from connected persons Bad debt relief is not available where a debt is due from a person connected to the supplier. Section 7A(3) of the VAT Act determines the criteria for establishing whether or not a person is connected with another person. Section 7A(3) is reproduced in Appendix 1 below. 8. Credit Notes VAT law provides that a trader, including one operating on the cash basis, is obliged to issue a VAT credit note for a reduction in consideration or the allowance of a discount after the issue of a VAT invoice. However, the question of issuing a credit note does not arise in the case of a bad debt written off. 9. How to make a claim A claim for bad debt relief should be made in the VAT return for the period in which the debt is written off. This should be done by increasing the VAT on purchases figure in Box T2 on the VAT return form. Relief for the bad debt is allowed at the rate in operation at the date of the issue of the original VAT invoice or, in the case of a supply to an unregistered person, at the rate in force at the time of supply. 10. How to calculate bad debt relief Where no payment has been received in respect of a supply, the relief will be in respect of the total amount of VAT accounted for on that supply. Where a partial payment has been received in respect of a supply the relief will be based on the amount of VAT that is still outstanding in accordance with the following formula: A x B B where: A is the amount which is outstanding from the debtor in relation to the taxable supply; and B is the percentage rate of VAT applicable to the supply 3
4 Example Bad debt relief for a supply, other than a supply under hire purchase: Sale Price of the Goods: 24,200 [B]VAT rate: 21.5% VAT amount accounted for on the supply: 4,282 Amount received from debtor: 14,520 [A]Amount outstanding from debtor: 9,680 The VAT adjustment for bad debt relief is is 1,713, calculated as follows: 9,680 x = 1, What if a customer pays everything but the VAT? If a customer pays the VAT-exclusive amount charged for goods or services but refuses to pay the VAT charged, the relief should be calculated by entering the total unpaid amount at A in the formula in the preceding paragraph. 12. Accounting for VAT on the recovery of a bad debt that has been written off If after claiming bad debt relief, an accountable person receives payment of any part of the debt he/she must make an adjustment to the bad debt relief already claimed. The adjustment should be made by reducing the VAT on purchases figure in Box T2 on the VAT return form for the period in which the payment is received. The amount of the adjustment should be calculated by using the formula in paragraph 10 where A is the total amount received from the debtor. 13. Property transactions Bad debt relief is not allowable in the case of leases, of ten years or more, which were created prior to 1 July
5 14. Bad debts determined after a transfer of business Where, as part of the transfer of a business in accordance with Sections 3(5)(b)(iii) or 5(8) of the VAT Act, the transferor of the business transfers debts that, subsequent to the transfer, are determined to be bad debts, there is no entitlement to bad debt relief. However, bad debt relief subject to the normal conditions is available in respect of any debts retained by the transferor that are not included in the transfer. 15. Insured debts An entitlement to receive compensation payment under a policy of insurance against bad debts does not affect entitlement to bad debt relief. This is not affected by any condition of an insurance policy that may assign the right to recover the debt to the insurer. 16. Third party payments, payments in kind and mutual debts No bad debt relief can be claimed to the extent that any payment is received by any third party in respect of a debt owed by a customer, e.g. payment by a guarantor or payment by a director of a debt owed by a company Payments in kind, e.g. goods or services bartered in exchange are also considered to be payments for supplies, valued at their open market prices. If a supplier owes an amount of money to a purchaser, which can be set off against the amount owing to the supplier, the consideration to be written off as a bad debt must be reduced by the amount owed by the supplier. 17. Factored and invoice-discounted debts Where a debt is assigned by one person to another without recourse, whether as part of a factoring or invoice-discounting arrangement or otherwise, the originator ceases to have an entitlement to any bad debt relief in relation to that debt. In a factoring or invoice-discounting arrangement, with recourse, the originator may be entitled to bad debt relief where all the other conditions in this leaflet are satisfied. Please refer to VAT Information Leaflet: Factoring and Invoice Discounting. 18. Reservation of title The sale of goods under an agreement for the reservation of title until the goods are paid for does not affect entitlement to bad debt relief. 5
6 19. Hire purchase Special rules apply to determine the amount of the relief in the case of hire purchase or credit sale. Please refer to VAT Information Leaflet Hire-Purchase Transactions. Further Information Enquiries regarding any issue contained in this Information Leaflet should be addressed to the Revenue District responsible for the taxpayer s affairs. Contact details for all Revenue Districts can be found on here. VAT Interpretation Branch, Indirect Taxes Division, Dublin Castle. December
7 Appendix 1 Section 7A(3) of the Value-Added Tax Act 1972 (as amended) Connected Persons (a). any question of whether a person is connected with another person shall be determined in accordance with the following: (i) a person is connected with an individual if that person is the individual's spouse, or is a relative, or the spouse of a relative, of the individual or of the individual's spouse, (ii) a person is connected with any person with whom he or she is in partnership, and with the spouse or a relative of any individual with whom he or she is in partnership, (iii) subject to clauses (IV) and (V) of subparagraph (v), a person is connected with another person if he or she has control over that other person, or if the other person has control over the first-mentioned person, or if both persons are controlled by another person or persons, (iv) a body of persons is connected with another person if that person, or persons connected with him or her, have control of that body of persons, or the person and persons connected with him or her together have control of it, (v) a body of persons is connected with another body of persons (I) if the same person has control of both or a person has control of one and persons connected with that person or that person and persons connected with that person have control of the other, (II) if a group of 2 or more persons has control of each body of persons and the groups either consist of the same persons or could be regarded as consisting of the same persons by treating (in one or more cases) a member of either group as replaced by a person with whom he or she is connected, (III) if both bodies of persons act in pursuit of a common purpose, (IV) if any person or any group of persons or groups of persons having a reasonable commonality of identity have or had the means or power, either directly or indirectly, to determine the activities carried on or to be carried on by both bodies of persons, or (V) if both bodies of persons are under the control of any person or group of persons or groups of persons having a reasonable commonality of identity, (vi) (I) (II) a person in the capacity as trustee of a settlement is connected with any person who in relation to the settlement is a settlor, or any person who is a beneficiary under the settlement. 7
8 (b) control, in the case of a body corporate or in the case of a partnership, has the meaning assigned to it by section 8(3B); relative means a brother, sister, ancestor or lineal descendant. 8
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