When a debtor does not pay, most businesses focus on recovering the money — which is exactly right. But unpaid invoices that are ultimately written off have tax implications that are worth understanding. The key issues are the GST input tax credit adjustment for bad debts, the income tax deduction for bad debts written off, and how both interact when an account is later recovered (whether by Merion or any other means).
This guide is general information only. Your specific tax position depends on your business structure, GST accounting basis and the terms of the relevant debt — speak to your accountant or tax adviser for advice that applies to you.
GST and bad debts
When you issue a tax invoice, you report the GST included in it to the ATO — typically in the BAS period in which the invoice is issued (for businesses on an accruals basis of GST accounting). If the customer does not pay, you have already remitted GST to the ATO on a payment you never received.
Under the GST law (GSTR 2000/2 and section 21-20 of the A New Tax System (Goods and Services Tax) Act 1999), you can make an increasing input tax credit adjustment to recover the GST component of a bad debt, provided:
- The debt has been written off as a bad debt in your accounts.
- You have not been paid for the supply.
- At least 12 months have passed since the due date for payment (or the debt has become genuinely irrecoverable before 12 months, such as where the debtor is in liquidation).
- You reported the GST when you first issued the tax invoice.
The adjustment is claimed in the BAS for the period in which the bad debt write-off occurs. Keep records to substantiate the write-off and the date.
Income tax deductions for bad debts
A deduction for a bad debt under section 25-35 of the Income Tax Assessment Act 1997 is available where:
- The debt is actually owed to you (not a contingent or uncertain amount).
- The debt was previously included in your assessable income — typically because you recognised the revenue when you invoiced, not when you were paid (accruals accounting).
- The debt has been written off as bad in your accounts during the relevant income year.
The deduction is available in the income year in which you write off the debt. A business on a cash basis of accounting — recognising income only when payment is received — generally cannot claim a bad-debt deduction, because the revenue was never included in assessable income in the first place.
What 'written off as bad' means
Both the GST adjustment and the income tax deduction require that the debt be 'written off as bad' in your accounts. The ATO's position (set out in Taxation Ruling TR 92/18 and the updated guidance for GST) is that a debt is bad when you have genuinely decided it is unrecoverable — not merely overdue. Factors relevant to that decision include:
- The age of the debt.
- The debtor's apparent financial position.
- Enforcement attempts made without success.
- The cost of further recovery relative to the likelihood of success.
Writing off a debt while actively pursuing recovery is not consistent with the debt being 'bad' — the ATO takes the view that a bad-debt deduction should reflect a genuine commercial decision that recovery is not expected.
When a written-off debt is later recovered
If you have claimed a bad-debt deduction and later recover the debt — for example, through a recovery agency — the recovered amount must be included in your assessable income in the year of recovery. Similarly, if you have claimed a GST adjustment and later receive payment, a decreasing adjustment (that is, repaying the GST to the ATO) is required.
Keep records of any bad-debt write-offs and subsequent recoveries so that the tax treatment can be correctly applied in both directions.
This guide is general information only. It does not constitute legal or financial advice. Tax rules change and your specific circumstances matter — obtain advice from a registered tax agent or accountant for your situation.