Credit notes or VAT bad debt relief claim – which?

Bad debts affect cash flow and financial stability, but VAT treatment depends on whether you issue a credit note or claim bad debt relief (BDR).

Credit Notes – Issued when:

• Overcharge or billing error.

• Goods returned.

• Discount applied after invoicing.

They reduce the customer’s balance and adjust VAT/accounting records for both parties. A credit note cannot be used for BDR and only has legal status when issued to the customer.

Bad Debt Relief (BDR) – Applies when goods/services have been supplied but unpaid. Conditions per invoice:

• VAT already accounted for and paid to HMRC.

• Debt written off in VAT accounts and moved to bad debt account.

• Supply value not above usual selling price.

• Not paid, sold, or factored via legal assignment.

• Unpaid for at least 6 months after payment/supply date (invoice date if none stated).

If later paid, VAT claimed must be repaid on the next VAT return.

Regulation 38 Adjustment – Original VAT charge can be reduced if:

• Genuine price reduction occurs.

• Refund issued to customer.

• Credit note issued within 14 days of decrease.

• VAT-registered customer reduces VAT claimed accordingly.

No time limit for Regulation 38 adjustments (even for invoices 5+ years old), but too late for a BDR claim.