Tax implications of writing off a bad debt
Writing off a bad debt can feel like admitting defeat, but from a tax perspective, it’s actually an important way to get some relief on money you’ve lost. Whether you’re a sole trader, partnership, or limited company, HMRC allows you to claim a deduction for irrecoverable debts – but only if you follow the rules. Let’s walk through what you need to know.
What counts as a bad debt for tax purposes?
Not every unpaid invoice qualifies as a bad debt write-off. HMRC takes the view that a debt must be genuinely irrecoverable before you can claim relief. This means you’ve taken reasonable steps to recover it – sending reminders, chasing payment, and exploring whether the debtor is solvent. A debt that’s simply overdue isn’t the same as a bad debt.
For a debt to be deductible, it must also have been recognised as income in a previous accounting period. You can’t write off a debt that was never properly invoiced or recorded. Additionally, the debt must be connected to your trading activities, so personal loans to friends don’t qualify, unfortunately.
The timing matters too. You should write off the debt in the accounting period when you become aware it’s irrecoverable – not when you formally pursue legal action or receive a court judgment.
Different rules for different business structures
Self-employed and partnerships claim bad debt relief on their Self Assessment tax return. You’ll include the write-off as an expense in your trading account, which reduces your taxable profit. For the 2024/25 tax year, basic rate relief means you get a deduction at 20% if you’re a basic rate taxpayer – though higher rate taxpayers get 40% relief on the amount written off.
Limited companies have a slightly different path. You claim the deduction against corporation tax, which is charged at 25% for profits exceeding £250,000 (and 19% for smaller profits under that threshold, from 1 April 2023). The deduction therefore saves you corporation tax at the company’s marginal rate.
One important distinction: if you’re a limited company and the bad debt is a trade receivable (money owed by customers), you can claim relief under the general rules. However, if it’s a loan you’ve made to another company, the rules are stricter – you may only get relief if the debtor is insolvent or the debt is statute-barred (six years old under the Limitation Act 1980).
Documentation and supporting evidence
HMRC will want to see evidence that you’ve genuinely tried to recover the debt. Keep records of:
- The original invoice and payment terms
- Correspondence with the debtor (emails, letters, payment reminders)
- Proof of when you became aware the debt was irrecoverable
- Details of any recovery attempts or legal action
- Bank statements showing non-payment
- Any correspondence confirming the debtor’s insolvency (if relevant)
This documentation is crucial. If HMRC challenges your write-off, you’ll need to demonstrate that the debt was genuinely irrecoverable at the time you claimed relief. A well-maintained credit control process strengthens your position considerably.
Partial write-offs and specific vs. general provisions
You don’t always have to write off 100% of a debt. If you recover part of it, you should only claim relief on the genuinely irrecoverable portion. Be precise about this – don’t round up or overestimate.
It’s also worth noting the distinction between a specific write-off (naming the exact debtor) and a general provision for bad debts. HMRC generally doesn’t allow relief for general provisions – you can only claim when specific debts are written off. This is why many businesses track bad debts individually rather than setting aside a lump sum.
Key things to avoid
Don’t write off debts between connected parties without solid evidence of irrecoverability – HMRC scrutinises these particularly carefully. Avoid writing off debts to related companies unless the debtor is genuinely insolvent. And don’t claim relief and then later recover the debt without adjusting your records – you’ll need to bring the recovery back into income.
Getting it right
Bad debt relief is a legitimate and valuable tax deduction, but it requires careful handling. The rules differ slightly depending on your business structure, and documentation is essential. Getting it wrong could trigger an enquiry, so it’s worth taking time to do it properly.
For tailored advice on your specific situation – whether you’re considering a write-off or facing a query from HMRC – we’d recommend speaking to a qualified accountant who understands your business.
For tailored advice, contact Severn Accounting — we’re here to help.