The tax treatment of a bad debt is often an afterthought in the recovery process — businesses focus, understandably, on trying to collect. But when recovery fails or is not worth pursuing, the write-off has real tax consequences that can either benefit or harm the business depending on how it is handled. The ATO has specific requirements and they are not onerous — but they do need to be followed.
What is a bad debt for tax purposes?
For income tax purposes, a "bad debt" is a debt that has been genuinely written off as irrecoverable in the income year. This is distinct from a debt that is merely overdue, slow to pay, or subject to a payment arrangement. The ATO's position is that a debt is bad when the creditor honestly and genuinely considers, on reasonable grounds, that the debt cannot be recovered.
A debt does not become bad merely because it is difficult to collect, because the debtor is reluctant to pay, or because the creditor has given up chasing. The determination must be a genuine commercial assessment that the debt is irrecoverable — not a year-end accounting adjustment to reduce taxable income.
ATO requirements
To claim a deduction for a bad debt, the ATO requires that:
- The debt must have been included in the creditor's assessable income in a current or earlier income year (i.e. it is a revenue debt, not a capital loan).
- The debt must actually be bad — not merely doubtful or difficult to collect.
- The debt must be written off during the income year in which the deduction is claimed.
The write-off must occur before the end of the income year. A debt that is written off after 30 June cannot be deducted in the year ending 30 June, even if it was clearly irrecoverable before that date. Timing matters.
There is no prescribed form for the write-off, but the ATO expects a genuine internal decision — typically a board resolution, a management decision documented in the creditor's accounts, or an accountant's sign-off — accompanied by records showing why the debt was considered irrecoverable.
GST adjustment on bad debts
If you are registered for GST and have already remitted GST on a supply that subsequently becomes a bad debt, you may be entitled to a decreasing adjustment — effectively a refund of the GST component of the bad debt. This is provided for under the GST Act and is commonly called a "bad debt adjustment".
The conditions are:
- You must have previously remitted GST on the sale (i.e. accounted for it on an accruals basis).
- The debt must have been written off as a bad debt.
- At least 12 months must have passed since the supply was made, or the debtor must be in administration or liquidation.
The adjustment is claimed in the BAS for the period in which the write-off occurs. The amount of the adjustment is 1/11th of the bad debt amount (the GST component). Cash-basis taxpayers who have not yet remitted GST on an unpaid invoice are not entitled to the adjustment — they simply do not report the GST until payment is received.
Documenting the write-off
Good documentation is essential, both for the income tax deduction and for the GST adjustment. You should maintain:
- The original invoice(s) and supporting documents for the debt.
- Records of collection attempts (demands, correspondence, payment history).
- A written internal decision or minute confirming that the debt has been written off as irrecoverable and the date of that decision.
- The reason the debt was considered irrecoverable (debtor in liquidation, absconded, assets nil, etc.).
These records should be retained for at least five years in case of an ATO audit. A bad debt that is later recovered — either by the creditor or by a liquidator distributing funds — must be brought to account as assessable income in the year of recovery.
Provisions vs write-offs
A provision for doubtful debts — an accounting estimate of the debts in your ledger that may not be recoverable — is not deductible for income tax purposes. The ATO does not recognise a general doubtful debt provision as a bad debt deduction. Only a specific debt that has been individually identified, assessed as bad and actually written off is deductible.
This is a common source of confusion: a business that makes a general provision of, say, 2% of its receivables each year will not be able to deduct that provision for tax. The deduction is available only when a specific debt is written off.
Recovering a written-off debt
Writing off a debt for tax purposes does not prevent you from continuing to pursue it — and does not prevent a recovery agent from collecting it. If the debt is later paid, in full or in part, the recovered amount is assessable income in the year of receipt. The tax deduction and the subsequent recovery are separate events in separate income years.
This means it is worth referring even a written-off debt to a recovery agent. The commission on recovery is deductible as a business expense; the recovered amount is income. The net position is usually better than writing it off and doing nothing.
This guide is general information only. It does not constitute tax, accounting or legal advice. Tax rules change and individual circumstances vary — consult a qualified accountant or tax adviser before acting on this information.