Before the financial year ends is the best time for small and medium sized businesses to assess outstanding invoices and bad debts. Many SMEs are no stranger to bad debts. As a business owner, you most likely have had customers who failed to pay for your goods and services.
You’ve performed the work, invoiced the customer, fixed a due date, waited for payment, but you waited in vain. You should write off these amounts.
A large business will typically have a payments team to pursue any invoices that are unpaid and receive payment. Small businesses may simply send out a few emails or make phone calls and then wait for payment.
What if the situation is your customer is unable to pay the money they owe you because of they are in a tough financial situation? Or if you had the misfortune of encountering a customer that makes it a habit to evade paying their debts?
You are not likely to be repaid because this is bad debt. So what remedies are available to you? One thing you can do is write it off as bad debt, as this may entitle you to a tax deductible expense.
If you own your own business you probably would have had experience problems in collecting payments on time. This kind of problem doesn’t just happen in Australia. In a survey performed by the Commercial Collection Agency Association in the USA, it was found that the chances of getting payment for the whole amount significantly decrease as time goes by.
The results showed that although most invoices are fully paid prior to the due date, the chances that you will receive payment at all has now declined by more than 50% by the time the due date arrives. After 30 days, this has declined even more to just 89.9% and 90 days following the due date, just 69.6% of invoice payments are received. It goes without saying that the number will go down from that point. Results showed that two year following the due date, the chances of getting paid for overdue invoices declines to just 9.3%.
An invoice blackhole is created, causing significant cash flow issues for businesses. This issue has been in existence ever since there have been standard business practices.
How to write off a bad debt
What are the steps for writing off bad debts? First, you must wait 12 months for the invoice to be overdue. After this period, the ATO will recognise that you are unlikely to get paid and let you write it off.
However, if you have recorded the amount as part of your assessable income either for the current year’s tax assessment return or for any past year, you may lodge the updated information about the non-payment to the ATO as part of your assessable income tax return. Make sure to lodge all the required papers prior to the conclusion of the financial year to avoid hindering the process.
Points to keep in mind
Per the Income Tax Assessment Act 1997, section 25-35:
“You can deduct a debt (or part of a debt) that you write off as bad in the income year if: (a) it was included in your assessable income for the income year or for an earlier income, or; (b) it is in respect of money that you lent in the ordinary course of your business of lending money.”
Don’t forget this when you are writing off bad debts. Below are some tips to help you through the process.
- Finish the process of writing off bad debts prior to the conclusion of the financial year. Though this reminder may seem obvious, you can easily forget about it when you consider all your accounting and tax responsibilities.
- You are only permitted to write off a debt that is bad to make sure you can claim a deduction. This means the debt is not likely to be paid.
- You must have documentation to support all debts that you will write off.
- The amount that you write off are subtracted from your profits, so be careful when writing off bad debts.
- You may claim a refund of the GST paid to the ATO on sales if you report your income on an accrual basis.
- When the amount has been overdue for over 12 months, it can be written off and GST credits claimed.
Before deciding to write off a bad debt, ensure you try all alternatives for collecting your Accounts Receivable balance. This is because it will affect profitability. Always remember to write off bad debts during the year and not when the financial year has ended.
Consult your accountant to help you in the process of writing off a bad debt. PJS Accountants offers accounting, taxation and other services to help you run your business affairs efficiently and in compliance with laws. Contact PJS Accountants for enquiries.