Q: I have a debt on the ledger, which is overdue by more than six months. After much chasing over a long period, the debtor has now agreed to pay the debt. However, he is saying that he should only pay the net amount as the debt is more than six months overdue and that I can, therefore, recover all the VAT under the bad debt relief rules. Is the debtor correct?
A: No. This point was tested up to the Court of Session in the case of Revenue & Customs Commissioners v Simpson & Marwick.
To be able to make a claim for BDR for VAT the creditor must have:
- accounted for the output tax on the supply and paid that output tax over to HMRC;
- written the debt off in the day to day VAT accounts and transferred it to a separate bad debt account, and
- more than six months must have elapsed after the due date for payment or the date of supply, whichever is the later.
However, BDR is calculated on the amount outstanding, so when a debtor makes a part payment of a debt, the payment is treated as being inclusive of VAT. For example, if the debt is £120 including £20 VAT and the debtor pays just £100, leaving £20 outstanding, then the VAT fraction of 1/6 is applied. The debtor is deemed to have paid £83.33 + £16.67 VAT. The VAT element of the outstanding part will be £3.33 and only this sum will be claimable as BDR. The claim is entered in Box 4 of his return.
There is a corresponding rule that applies to the debtor. This means that where he has not paid a creditor and there is an amount outstanding more than six months after the due date for payment, then any input tax claimed on this unpaid element must be repaid to HMRC.
The debtor, in this case, should have repaid the input tax in full to HMRC in the period when the debt went over six months old. Assuming he has done this correctly, if he now pays the net amount only, he will need to treat the amount he pays as VAT inclusive and apply the VAT fraction to see how much of the input tax he can recover, and would put that figure into Box 4 of his return in the period when he makes the payment.
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