Dealing with bad debts

Any business with a bad debt will naturally try to take steps to try to recover it. However, eventually you have to take a view on these things and perhaps write it off. If you go about this the right way you can claim bad debt relief and your tax bill may be reduced. And, if you’re VAT registered you can also claim back the VAT.

Go about it the wrong way and there is a risk that you will lose out even more. I’ve seen that happen and I’ve seen the VAT office recover VAT which was reclaimed in good faith, but which was reclaimed incorrectly.

Firstly, be commercial! Make an effort to recover the debt. Send reminders to the client, or to the administrator or to the receiver. Be persistent. If after 6 months you are getting nowhere, then you can consider bad debt relief. No tax relief will be allowed until 6 months after the invoice date.

Assuming that writing off the debt is your only option, you then have to generate a document (a copy of the original invoice will do) and mark it “Bad Debt”. This “expense” is then shown in your books as though you had bought something. It is not a negative invoice, nor is it a credit note, it is simply an expense and there is a special “bad debt” category for this type of expense.

Like any other expense, it goes through the books, leads to a reduced profit, and in turn to a reduced tax bill. And if there was VAT on the original document, then there is VAT relief on the corresponding bad debt. Treat it as you would any other expense from a VAT registered supplier.

Just be sure to try 6 times over 6 months to recover the debt. At the point where you write it off as a bad debt you must inform the client that you consider this to be a bad debt and, accordingly, you are claiming bad debt relief. That way, the tax man and the VAT man will be content that you have followed the rules.

Employed and self employed at the same time

Will I pay tax twice?

In this article self employment means just that. A person is self employed if they run their business for themselves and takes personal responsibility for its success or failure. A self employed person can also be sued, and risks losing everything they own.

Self employment does not mean running a limited company which offers freelance services and which has limited liability protection, for example “send in the bailiffs to seize this pen and this laptop, sell them at auction and see what you get”. In a legal sense a freelancer running a limited company is special type of employee.

So, if you’re both employed and self employed at the same time, this is what you need to know.  For tax purposes, all of your income in a single tax year is lumped together and the tax calculation is a single exercise. Nobody should have to pay tax twice.

However, with National Insurance Contributions, the system is peculiar and there is often a risk of paying too much.

Having said that, both the Revenue and the Contributions Agency have been know to make mistakes, lots of mistakes. So it’s worthwhile having an accountant check the position.

If you are one of those people who dips in and out of employment, and in and out of self employment, then it’s worthwhile keeping very close tabs on start dates and end dates with your different engagements, and records of all income and expenses. When you have a major project (and are working under PAYE) it does not mean that your self employment ceases. The best thing is to keep your status as self employed until such time as you know that there is not going to be any more self employed work.

That saves you from having to register and de-register as self employed on a regular basis. It also means that in lean times, any loss you make on the self employed business can be set against your PAYE income. So if you still spend money on prospecting, phone calls and advertising (in the course of your self employment) your losses can sometimes result in a repayment of PAYE taxes.

The 50% Payment on Account Dilemma

It’s normal for some people to make tax payments on account every 6 months

If you’re self employed, or have lots of income from rent, dividends or investments, you may have become used to the pattern of making tax payments every 6 months.

However, the way the rules are structured, it normally comes as a bit of a surprise the first time you encounter the the “payments on account” regime. PoA for short. If most of your tax is paid under PAYE you won’t need to worry about this. The rule is twofold:

  • If your PAYE tax deduction (and any sundry tax deduction) is more than 80% of your total tax bill, then PoA do not apply.
  • If your total tax payment for the year comes to less than £1,000 then PoA do not apply.

In all other cases, individuals (but not companies) will have to pay an instalment of tax every 6 months, on 31 January and on 31 July. And that normally applies to people who are self employed or have lots of income from rent, dividends or investments. The best way to explain this is to give you an illustration, based around the chart below. Let’s say that. . .

  • your taxable income first arose in the tax year 2015/16
  • your 50% payments on account are based on the previous year’s tax bill
  • as the previous year’s tax bill (2014/15) was NIL, you made no PoA on 31 Jan 16 and 31 Jul 16
  • when your tax return was finalised, your 2015/16 tax bill came to £999 and you paid that on the normal due date of 31 Jan 2017
  • that amount was below the £1,000 limit and so your PoA for 31 Jan 17 and 31 Jul 17 were also set at NIL
  • and then you go and have a really good year in 2016/17

  • so good, that your 2016/17 tax bill comes to £8,888
  • now you’re caught
  • not only do you have to pay the 8,888 on the normal due date of 31 Jan 2018, but the PoA kick in at the same time
  • the first instalment of 4,444 for 2017/18 is due on the same day – 31 Jan 2018 – in this illustration that’s going to lead to a single payment of £13,332
  • and another £4,444 is going to be due on 31 Jul 2018
  • if the payments on account of £4,444 and£ 4,444 are not precisely right for 2017/18 then a TBA adjustment is made on 31 Jan 2019
  • that could mean more tax to pay, or a tax repayment
  • and the next 50% instalment will also be due on 31 Jan 2019, and so on

It sometimes looks like you have to pay 2 years worth of tax in the space of 6 months. It has often been said that “if you’re self employed you don’t pay tax for two years”. That’s sort of true, but then it all catches up with you and you end up paying two years worth of tax in the space of 6 months.

We know what you’re thinking and we’ve heard the message before. You can contact your MP here (use the search labelled “Find an MP by postcode”). We simply have to follow the rules!

The only way to keep things under control is to regularly put aside a tax reserve and to do your accounts and tax return soon after 5 April every year. Then there should be no nasty surprises.

A Reduction?

What happens when you have a really good year followed by a really bad year? Your payments on account in the new year are automatically based on your tax bill for the old year, because HMRC (and the legislation) assumes that your taxable income will continue on a steady trajectory, going up.

When it goes down, you may struggle to pay high instalments. And you don’t have to.  There is a mechanism to apply for a reduction, and it’s called the SA303 process. Let us know if this is relevant to you.

Before the 31 January tax payment date we may be able to work with your figures for 9 months of the tax year (to 31 December) and make a reasonable judgement call on the picture for 12 months, and hence deduce what a reasonable instalment would look like. For relevant clients, we follow this routine in the first two weeks of January each year, and provide advice before the end of the month. It’s important though to ensure that we have 31 December figures just after December ends.

January is our busiest month of the year, in the run up to the 31 January tax payment date, and tax return submission deadline. We will do the best we can, and it’s a case of first come first served.

The knock on effect

If it turns out that the new instalments are too low, and that insufficient tax is going to be paid, then an additional tax bill, and late payment interest are inevitable. Therefore, when the January SA303 is prepared, a pragmatic approach is needed, and it would be unwise to “just ask for instalments of NIL”.

In any case, whether we over or under estimate, it’s usually a good idea to have the next tax return prepared soon after 6 April and before the second instalment is due on 31 July.

Income Tax & Corporation Tax Payments

There are four methods for paying a tax bill

We recommend making payments by bank transfer as this is the best way to prove that the amount was paid and was paid on that date!

Method 1 – Internet Banking

If HMRC sent you a payslip it will state whether you need to pay Shipley or Cumbernauld.

If you have no payslip then the default position is to make personal tax payments to Shipley and company tax payments to Cumbernauld. There are a lot of cases which do not follow this pattern, but don’t worry about it. HMRC sometimes moves cases around to even out the workload.

Depending on your bank, they may already have HMRC Shipley or HMRC Cumbernauld set up on their system. If the bank does not have the precise account details already, then you will need to specify one of these two:

account name HMRC Shipley
sort code 08-32-10
account no. 12001020
ref – your unique taxpayer reference number (the UTR)

account name HMRC Cumbernauld
sort code 08-32-10
account no. 12001039
ref – your unique taxpayer reference number (the UTR)

These bank accounts do not work with the modern “faster payments” system which we are all now used to. It normally takes at least 24 hours for a payment to arrive. Do not pay on the last possible date, it will not arrive until the next banking day and that will make your payment late!

If it’s a personal tax payment add a capital letter K to the end of your 10 digit UTR.

12345 67890 K

If it’s a company tax payment, the 10 digit UTR needs to be followed by the “accounting period”. Please try to follow this format as HMRC is prone to getting payments, putting them in the wrong place, and then claiming that they didn’t receive it in the first place! Replace the letters NN here with the numbers which we provide in our email.

12345 67890 A001 NN A

If your tax liability is more than £10,000 you may find that you will exceed your bank’s limit on internet transfers. Two smaller amounts paid on two separate days should enable you to work around that problem.

Method 2 – Traditional Cheque and Payslip

Companies are compelled to pay corporation tax electronically with effect from 1 April 2011. You can still use cheques to pay personal taxes.

If you have a recent reminder, payslip and prepaid envelope, please use that when making your payment. Write out a cheque for “H M Revenue & Customs” and put your unique taxpayer reference number on the front and on the back! Post it in good time so that it arrives by the due date! Thanks.

Method 3 – Debit Card

Use a debit card and pay by phone. Call the Collector of Taxes on 0845 305 1000 and quote your 10 digit unique taxpayer reference number. Then ask for a payment reference number or authorisation code for this payment.

Method 4 – Covering Letter and Cheque

Companies are compelled to pay corporation tax electronically with effect from 1 April 2011. You can still use cheques to pay other taxes.

If you cannot use any of the above methods, please use the dialogue below as the basis for a covering letter (using your normal business letter headed paper) and send it with a cheque, to the Collector. Write out a cheque for “H M Revenue & Customs” and put your unique taxpayer reference number on the front and on the back!

The Collector of Taxes
Accounts Office B
W Yorkshire
BD98 8AADear SirsI enclose a cheque in the sum of AMOUNT which represents tax due on DATE for the period ended YEAREND, under your ref REFNO.

Yours faithfully