One of the most frustrating aspects of running a business is having to pay VAT to HMRC on sales that you haven’t actually been paid for.
Many business owners are surprised to discover that under the standard VAT accounting method, VAT becomes payable when you issue an invoice, not when your customer pays it. If that customer subsequently fails to pay, you can end up out of pocket twice – once for the unpaid invoice and again for the VAT you’ve already handed over to HMRC.
The good news is that there are ways to recover that VAT.
VAT and bad debts – the basic rule
If you’ve issued an invoice, accounted for the VAT and paid it to HMRC, but your customer doesn’t pay, you may be able to claim VAT Bad Debt Relief. To qualify, all of the following conditions must be met:
- The invoice must be at least six months overdue.
- The debt must be written off in your accounts as a bad debt.
- The debt must still be unpaid.
- The debt must not have been sold or assigned to another party (such as a debt collection or factoring company).
Once these conditions are satisfied, you can reclaim the VAT through your next VAT return.
Example
ABC Limited issues an invoice for £12,000 including VAT (£10,000 plus £2,000 VAT). The company includes the £2,000 VAT on its VAT return and pays it to HMRC. Unfortunately, the customer goes into liquidation and six months later it becomes clear that the debt will never be paid. ABC Limited writes off the debt in its accounts and can reclaim the £2,000 VAT through its VAT return.
While this won’t recover the lost sale, it does at least return the VAT element to the business.
Could a credit note be faster?
In some situations, a credit note can provide a quicker route to VAT recovery. For example, you may agree with a customer to reduce the amount owed in exchange for immediate settlement of the balance. If you issue a valid credit note, you can reduce the VAT due accordingly.
Example
You issue an invoice for £6,000 including VAT. After a dispute, you agree to accept £4,800 in full and final settlement. You issue a credit note for the £1,200 reduction and adjust your VAT return accordingly. This approach can be useful because it avoids having to wait six months before recovering some of the VAT.
Don’t miss the deadline
Many businesses are unaware that claims for VAT Bad Debt Relief are time limited. You generally have to make the claim within four years and six months from the later of the invoice date, or the payment due date. If you leave it too long, the opportunity may be lost. Regular reviews of your aged debtors ledger can help identify invoices approaching the deadline.
Equally important: pay your suppliers on time
There is another VAT rule that often catches businesses out.
If you’ve reclaimed VAT on a supplier invoice but fail to pay that supplier within six months, HMRC may require you to repay the input VAT that you originally claimed. This rule is often overlooked, particularly by businesses experiencing cash flow difficulties.
Example
Your business receives a supplier invoice for £3,000 plus £600 VAT. You reclaim the £600 VAT on your VAT return. However, six months pass and the supplier remains unpaid. Under the VAT rules, you are generally required to adjust your VAT return and repay the £600 to HMRC. If you later pay the supplier, you can reclaim the VAT again.
Why this matters
Many businesses focus heavily on collecting money from customers but pay less attention to the age of unpaid supplier invoices. During an HMRC VAT inspection, officers frequently review:
- Aged debtor reports
- Aged creditor reports
- Bad debt write-offs
- VAT adjustments
Businesses that haven’t made the required adjustments can face unexpected VAT assessments, interest and potentially penalties.
Practical steps for business owners
To stay compliant and maximise VAT recovery:
- Review aged debtors regularly – identify invoices that are approaching six months overdue and assess whether bad debt relief may be available.
- Chase debts early – the sooner you act, the greater the chance of recovering the cash rather than relying on VAT relief.
- Monitor aged creditors – keep an eye on supplier invoices that remain unpaid for more than six months.
- Write off genuine bad debts properly – the debt must be written off in your accounting records before bad debt relief can be claimed.
- Keep supporting records – maintain evidence of unpaid invoices, credit notes and accounting entries in case HMRC requests them.
How eba Can Help
As part of our ongoing bookkeeping, VAT and accounts services, we monitor client records for VAT issues and opportunities. Where appropriate, we’ll identify:
- Potential VAT bad debt relief claims.
- Supplier invoices that may require VAT repayment adjustments.
- Credit note opportunities.
- VAT compliance risks before they become costly problems.
If you’re concerned about unpaid customer invoices, cash flow pressures or VAT compliance, speak to the eba team. A simple review could help improve cash flow and ensure you’re not paying more VAT than necessary.
Final note
The VAT Cash Accounting Scheme can help businesses improve cash flow by accounting for VAT only when payments are received from customers, rather than when invoices are issued. A business can join the scheme if it is VAT registered and expects its annual taxable turnover (excluding VAT) to be no more than £1.35 million. Once in the scheme, the business can remain in it until its taxable turnover exceeds £1.6 million. The scheme is particularly beneficial for businesses that offer credit terms to customers, as it avoids having to pay VAT to HMRC before the customer has paid the invoice. However, input VAT on purchase invoices can only be claimed once the invoices have been paid, so there would be no VAT relief for purchase invoices unpaid at the end of a VAT quarter.
The VAT Cash Accounting Scheme is, in general terms, suitable if your customers take longer to pay you than you take to pay your suppliers.
