Deductions
Bad debt
A bad debt is an amount owed to your business that you have decided you cannot collect and have written off, which may give rise to income tax and GST consequences.
A bad debt arises when a customer owes your business money and, after reasonable efforts to collect, you conclude the amount will not be paid. Typical causes are the customer becoming insolvent, disappearing, or the cost of recovery outweighing the amount owed. Simply being slow to pay does not make a debt bad. You need to make a genuine decision, and record it, that the debt is not recoverable.
For income tax, a deduction for a bad debt is generally available only if the amount was previously included in your assessable income and you write it off as bad before the end of the income year. This is why bad debt deductions are usually relevant to businesses that report income on an accruals basis, where sales are counted when invoiced. A business reporting on a cash basis has not counted the unpaid sale as income, so there is normally nothing to deduct.
The write-off has to be a real step, such as a journal entry in your accounts or a written decision, made by the end of the income year. A director or owner should document why the debt is considered uncollectable. If you later recover some or all of the amount, the recovery is generally included in your assessable income in the year you receive it.
GST is dealt with separately through a bad debt adjustment. If you have already paid GST to the ATO on a sale that is never paid, you may be able to get that GST back by claiming a decreasing adjustment in your BAS once the debt is written off. A business using cash accounting for GST only pays GST when it receives payment, so there is usually no GST to recover on an unpaid sale.
The customer's side matters too. A buyer who claimed a GST credit on a purchase but has not paid the supplier for a long time may have to repay that credit through an increasing adjustment. This is one reason it is worth keeping accounts payable up to date and communicating with suppliers about disputed or unpaid invoices.
Common misunderstandings are treating any slow-paying debt as bad, forgetting to write the debt off formally before year end, and overlooking the GST side. Good credit control, written terms and prompt follow-up reduce bad debts in the first place. This is general information only, so confirm your situation with the ATO or a registered tax professional.
Worked example
A registered business invoices a customer $5,500 including GST, so $500 GST was reported in an earlier BAS on an accruals basis. After collection efforts fail, the owner writes the debt off as bad before 30 June. The business can claim an income tax deduction for the $5,000 GST-exclusive amount that was included in income, and may claim a decreasing adjustment of $5,500 / 11 = $500 for GST in a later BAS.
Practical tips
- Write the debt off formally, in your accounts and with a note of why it is uncollectable, before the end of the income year.
- Cash-basis businesses usually have no income tax deduction or GST adjustment to claim, because the sale was never counted.
- If a debt is later recovered, remember to include the recovered amount and consider the GST effect.