Be careful when claiming bad debts

A bad debt can be claimed as a tax deduction.  And with the end of financial year rapidly approaching, now is the time to determine what can be written off.

Probably the more important discussion is how to avoid bad debts in the first place.  That will be left to a future post.

To claim a bad debt, it must have already been reported as income.  That means those who report their income for tax purposes on a cash basis can’t claim a bad debt.

So for those who recognise income on an accruals basis – meaning income is recognised when the invoice is raised – they must have reached a position where all reasonable attempts to collect have failed.  It must therefore be more than doubtful. 

You then need to make an entry into your accounting system.  Those who are using a cloud file must process the bad debt in June.  Don’t fall for the trap of ding it later as cloud systems time date entries.

But what if I collect the money later?

There are genuine cases where this happens.  The customer could come into money through an inheritance or windfall and do the right thing and pay back their creditors.  In that case, you re-recognise the income as a bad debt recovered.

Beware of schemes of arrangement

Sometimes a business may not write off a debt but later accept so many cents in the dollar from a liquidator’s offer.  The problem here that accepting say 40 cents in the dollar does not entitle you to claim the other 60% as a bad debt.  So keep on top of your customers and ensure you write off bad debts as soon as you can.

Tip 

It is always a good idea to document the attempts you have made.  That way you will have some contemporaneous evidence as to your decision if the ATO start asking questions.

As I already said, the real question is what can you do to prevent bad debts in the first place – we welcome that discussion with you.

At MRS, we will spend today planning for your success.