Here\’s a little tax question

When can a business write off a bad debt for tax purposes?

The reason I ask is:

An analysis by Experian of millions of supposedly solvent firms that decided to close down voluntarily revealed that they are in fact leaving behind combined \’hidden’ average debts of £4.7bn each year.

This compares to the £11.7bn left by businesses that went through insolvency proceedings last year.

Obviously, in the management or firm accounts that debt is written down when there\’s even a suspicion it won\’t be paid. But what about the tax accounts?

Specifically, do you need the letter from the insolvency process to make that debt allowable as a loss?

If so, wouldn\’t this mean that too much tax is being paid?

I really don\’t know the answer which is why I ask.

14 comments on “Here\’s a little tax question

  1. There’s no ‘official process’ such as lettters to act as proof. As long as it’s more likely than not that the debt will not be received and the provision is specific to a customer rather than “we think we may not receive 3% of outstanding debtors” then you will get the tax relief.

    Auditors may look at the appropriateness of the bad debt provision and enquire as to why you believe they should/should not be written off or provided against and they act as the first barrier to fraud for anything but audit exempt companies.

    The double entry accounting system ensures that if the debt is written off but subsequently received (say in the next tax year) then you’ll pay the additional tax albeit it later giving a minor cash flow avdvantage.

  2. Broadly, when you provide for it in your financial accounts as a doubtful debt. For UK GAAP accounts the provision has to be on a specific debt to be allowable for tax – not a general provision for all debts. Under IFRS it is what you provide for as there are no general provisons. No need for an insolvency process. Arrears can be enough as you only need doubtful debts not realised bad debts.

  3. For corporation tax or income tax on self-employment you should have no reasonable expectation that the debt will be paid in full.
    It is different for VAT: unless you register to pay VAT on a cash basis of accounting you have to pay VAT on bad debts and later reclaim it when the debtor has formally defaulted.

  4. The whole thing sounds like bollocks to me. It’s just Experian trying to sell their credit rating services.

    Very simply, a solvent liquidation is a solvent liquidation, and an insolvent liquidation is an insolvent liquidation. A solvent liquidation does not leave debts. If there are debts left behind, it’s an insolvent liquidation and treated as such. That companies can be put into insolvent liquidation by the directors without insisting on being ordered to by the courts is neither here nor there.

  5. “The whole thing sounds like bollocks to me. It’s just Experian trying to sell their credit rating services.

    Very simply, a solvent liquidation is a solvent liquidation, and an insolvent liquidation is an insolvent liquidation. A solvent liquidation does not leave debts. If there are debts left behind, it’s an insolvent liquidation and treated as such. That companies can be put into insolvent liquidation by the directors without insisting on being ordered to by the courts is neither here nor there.”

    Agreed!

    It’s worth noting that there are material differences between GAAP and tax law when it comes to recognizing and measuring losses connected to troubled debt.

  6. What’s wrong with counting the money at the beginning of the year, then counting the money at the end of the year, and taxing the difference if positive?

    Sod accounting niceties, disputes about bad debts, writedowns of capital equipment (just incur the cost when it arises). And free up millions of accountants and taxmen to do something productive.

  7. “writedowns of capital equipment (just incur the cost when it arises).”

    Good luck building a nuclear power station with that accounting treatment.

    you have to account for assets on your balance sheet and the way that they gradually lose their value over the course of their useful life.

    If you can’t do this, you will never be able to raise any funding – debt or equity – because you will no net asset value on your books to show for it.

  8. The mystery is why we tax company *profits* but individuals’ *income*.

    Or why we tax both at all.

    Is it just me that thinks we should just have one tax that is an income tax, same percentage for all, with an allowance before paying anything somewhere between 10 and 20 grand? Would be lovely and simple. Everyone registers in one and only one country, and is only entitled to free government services from that country. You can register in The Caymen Islands if you like, but then you don’t get covered by the British NHS, dole, etc. That kind of thing.

    Not much good for the accountancy profession, mind. But good for everyone else.

  9. Ian B

    Try taxing individuals’ “profits” and just hear them squeal.

    Are you suggesting that companies should be taxed on turnover, not profits?

  10. Well, I’m with Tim in thinking they shouldn’t be taxed at all. But it’s strange to tax individuals on turnover and companies on profits.

    I don’t know whether individuals would “squeal” at a profit tax. Many people wouldn’t pay any at all, and rich people would pay a lot, which would make Ritchie happy.

    Of course, they’d then start dodging it by having companies provide their cars and homes, and taking very low direct incomes. But Ritchie would sort them out with his shining sword of truth.

    Okay, seriously. Why tax the turnover of an office cleaner but only the profits of the company whose office she cleans? Ought to be one or the other, surely.

  11. Ian B

    Profits are the excess of income over consumption – i.e. savings. You want everyone’s pension savings to be taxed? Believe me they’ll squeal. Indeed they already are doing. Just listen to the noise about Osborne’s suggestion that pension tax relief may be reduced for higher earners.

    However, “income” tax is not supposed to be a turnover tax. The principle of the “personal allowance” was that essential consumption (housing, food etc) should not be taxed. In other words, income tax with a tax-free allowance is taxation of disposable income – which is profits. But because for years and years the personal allowance was not raised in line with inflation, nowadays no-one can realistically live on that amount of money and therefore individuals ARE taxed on turnover. This idiotic situation needs rectifying. We should not be taxing people on the minimum wage (or part-time equivalent) – or in London, the living wage – at all.

  12. Believe me they’ll squeal. Indeed they already are doing.

    Well yes, but that’s because we have so many different taxes, so you’re paying an income tax, then getting taxed again when you save it for a pension, then again if you buy something with it (VAT), then again if you buy something, die, and it’s inherited and on and on.

    If there were only a “profits” tax on inividuals rather than what is currrently effectively a turnover tax, that would be different. Right now, we’re taxing both.

  13. Ian B,

    It isn’t quite like that. Currently you don’t get taxed even once when you save for a pension. Contributions are made from untaxed income.

    You do get taxed twice on “non-essential” consumption. But then it’s non-essential, innit?

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