Now that the 2002 Finance Bill has received Royal Assent and become law (on 24 July 2002), it is worth considering a subtle, but very important change to the rules concerning the VAT treatment of debts that are considered to be “bad” i.e. an invoice has been issued by a supplier, and is possibly unlikely to be paid. The key point is that whilst the rules as regards the supplier have been relaxed, the rules for the customer now contain a significant trap for the unwary.

The pre 2002 Finance Act rule was that the VAT element of a “bad” debt could be reclaimed from Customs providing three main conditions were fulfilled: (1), that the debt had been written off in the supplier’s accounts; (2), that the debt was at least six months old; (3), that the supplier had notified the customer of the fact that he had made a claim for VAT bad debt relief.

This final condition often proved to be something of a disincentive to making a claim as generally a supplier would not want his debtor to know that he had written the debt off. If a debtor did receive a notification as mentioned at (3) above, he was then supposed to adjust his own VAT account and repay to Customs the input VAT that he had claimed.

If the bill is six months old it’s a bad debt

Following the passing of the 2002 Finance Act, it is no longer necessary for the supplier to notify his customer when he claims VAT bad debt relief (although conditions (1) and (2) above do still apply). From the supplier’s viewpoint, this is a useful relaxation of the rules. However, the requirement for the customer to repay to Customs input VAT when the debt has not actually been paid is no longer dependent on the receipt of a notification from the supplier. Instead, a general requirement has been introduced for debtors to repay input VAT in the VAT quarter in which any debt becomes six months old.

It is likely that in future Customs will take a keen interest in the VAT position in respect of old creditors and attempt to claw back input VAT that has been claimed, together with interest and surcharges.

Barnes Roffe Topical Tips

• Suppliers should review their sales ledger balances and see whether they can now claim VAT refunds in respect of debts that are over six months old.
• Purchasers of goods and services should put in place purchase ledger review procedures so that the VAT position on post 24 July 2002 purchases that remain unpaid for more that six months can be checked.