The end of the financial year (30 June) usually prompts a review of bad and doubtful debts. So, it is worth revisiting the GST rules that apply to bad debts.
The GST law contains specific rules for dealing with bad debts. However, those same rules also contain a rule regarding overdue debts. Specifically, circumstances where a debt is overdue for more than 12 months, irrespective of whether the debt is bad or not.
The rules are found in Division 21 of the GST law:
- Section 21-5 deals with bad or overdues debts for taxable supplies;
- Section 21-10 deals with recovery of previously written off or overdue debts for taxable supplies;
- Section 21-15 deals with bad or overdue debts for creditable acquisitions; and
- Section 21-10 deals with recovery of previously written off or overdue debts for creditable acquisitions.
Bad or overdue debts for taxable supplies
Section 21-10 states as follows:
(1) You have a decreasing adjustment if:
(a) you made a *taxable supply; and
(b) the whole or part of the *consideration for the supply has not been received; and
(c) you write off as bad the whole or a part of the debt, or the whole or a part of the debt has been *overdue for 12 months or more.
The amount of the decreasing adjustment is 1/11 of the amount written off, or 1/11 of the amount that has been overdue for 12 months or more, as the case requires.
(2) However, you cannot have an *adjustment under this section if you *account on a cash basis.
Firstly, the reason these rules do not apply to entities that account for GST on a cash basis (see section 21-5(2) above), is that for such entities the GST liability only arises to the extent an amount of cash has been received in relation to a taxable supply. If no cash has been received, no GST becomes payable. Therefore, if the debt is subsequently written off, and there has been no GST payable, there is no need for any GST adjustment to take place for the bad debt.
Secondly, for entities that account for GST on a non-cash basis (i.e., accruals basis) the GST liability for a supply is attributed to the tax period in which either an invoice is issued, or if earlier any or all of the consideration is received.
By way of practical example, assume an invoice has been issued by a Supplier on 30 March 2021 for a taxable supply of $1,100 (including GST) with a payment due date of 15 April 2021. The GST liability of $100 would be attributed to the March 2021 tax period of the Supplier (i.e., included in the March 2021 BAS). The GST would be paid to the ATO when the BAS is due for lodgement and payment – either 21 April 2021 if it is a monthly BAS, or 28 April 2021 if it is a quarterly BAS.
Thirdly, for entities that account for GST on an accruals basis, the GST attribution of input tax credits is also triggered by similar rules – that is, the credits are attributed to the tax period in which the Supplier issued an invoice, or if earlier, the tax period in which the Recipient has provided some or all of the consideration. For completeness we note that the Recipient must also hold a Tax Invoice at the time of lodging the relevant BAS to be able to claim input tax credits.
Again, by way of practical example, assuming an invoice (which is a Tax Invoice) has been issued by a Supplier on 30 March 2021 for a taxable supply of $1,100 (including GST), the GST credit of $100 would be attributed to the March 2021 tax period of the Recipient (i.e., included in the March 2021 BAS). The benefit of this credit would be received when the BAS is lodged – either 21 April 2021 if it is a monthly BAS, or 28 April 2021 if it is a quarterly BAS.
Finally, without the adjustment rules for bad and overdue debts, a Supplier may be out of pocket for the GST (having paid GST but not collected any payment from the Recipient), and a Recipient will have the benefit of the GST credit (having claimed it but without having paid anything to the Supplier).
The key provision from section 21-5(1) is paragraph (c) which can be triggered under two circumstances:
- Bad Debts – if the whole or part of the debt is written off as bad; or
- Overdue Debts – if the whole or a part of the debt has been overdue for 12 months or more.
For the bad debts provisions to operate, there must firstly be a ‘bad debt’.
The ATO has issued public ruling GSTR 2000/2 ‘Goods and Services Tax: adjustments for bad debts’, setting out its comments on the application of Division 21.
Paragraph 37 of GSTR 2000/2 considers a debt to be bad where an entity makes ‘a bona fide assessment, based on sound commercial considerations, that the debt is bad’. According to the ATO, if there “is still a real and continuing dispute in relation to the sum” this would not reflect a bad debt based on sound commercial judgement. However, if after taking appropriate steps to recover the debt, no amount is recovered and the entity considers there is little or no likelihood of recovering the debt, then the debt would be bad.
Once there is a bad debt, steps must also be taken to write off the bad debt. The ATO makes the following comments in GSTR 2000/2:
- Before you are entitled to make a decreasing adjustment under Division 21 for a debt that has not been overdue for 12 months or more, the debt must be written off.
- Writing off will generally be evidenced if there is some form of written record to that effect. The debt may, for example, be written off by journal entries in the books of account.
- Under the bad debt provisions of the income tax legislation, a debt cannot be written off after it has been settled, compromised or otherwise extinguished. In these situations, there is no longer a debt in existence that may be written off.
- These same principles apply to Division 21. For example, if you settle a debt before writing it off, or before the 12 months have elapsed, there will be no debt in existence for the application of Division 21. The settling or compromising of a debt may be treated as an adjustment event for the purposes of paragraph 19-10(1)(b) which deals with adjustments for changes in consideration.
In the context of a Supplier making a taxable supply, if the amount owing is written off as a bad debt, this will trigger a decreasing adjustment for the Supplier. As GST adjustments are attributed to the tax period in which the entity becomes aware of the adjustment, the decreasing adjustment will arise in the period that the debt is written off.
Applying this to the example above where the $1,100 invoice is issued on 30 March 2021, if after attempting to recover the debt unsuccessfully the Supplier writes off the whole of the debt as bad in January 2022, the decreasing adjustment of $100 (being 1/11th of the $1,100 bad debt written off) is included in the January 2022 tax period/BAS (if monthly) or the March 2022 tax period/BAS (if quarterly).
For debts that have not been written off, whether they are doubtful, bad or otherwise, there is a ’12 months’ overdue rule.
The first step is to understand when the debt becomes ‘overdue’. This is defined in the GST law as:
“A debt is overdue if there has been a failure to discharge the debt, and that failure is a breach of the debtor’s obligations in relation to the debt”
Again using the example from above, we note the invoice is issued on 30 March 2021 but the terms indicate a payment due date of 15 April 2021. Therefore, the debt only becomes ‘overdue’ if it has not been paid by 15 April 2021. On this basis, the debt will only have been overdue for more than 12 months if the debt remains unpaid on 15 April 2022.
In the context of a Supplier making a taxable supply, if the amount owing is overdue for more than 12 months, this will trigger a decreasing adjustment for the Supplier. As GST adjustments are attributed to the tax period in which the entity becomes aware of the adjustment, the decreasing adjustment will arise in the period that the debt becomes 12 months overdue. This appears to be a mandatory rule, and unlike the rules for claiming GST credits, there does not appear to be any basis for including the adjustment in a later tax period/BAS.
Applying this to the example, the decreasing adjustment of $100 is included in the April 2022 tax period/BAS (if monthly) or the June 2022 tax period/BAS (if quarterly).
Bad or overdue debts for creditable acquisitions
The above has dealt with the adjustments that arise for the Supplier of a taxable supply. However, Division 21 also contains rules that apply to a Recipient who has made a creditable acquisition where the debt is written off as bad or the debt is overdue for more than 12 months.
Similar to the taxable supply rules, if the Supplier writes the debt off as bad, this triggers an increasing adjustment (i.e., GST liability) on the Recipient. A Recipient is unlikely to be informed by a Supplier that a debt has been written off as bad. However, if the Recipient became aware that the debt was written off as bad, then this would trigger attribution of the increasing adjustment.
Using the above example, and assuming the Recipient became aware the Supplier wrote the debt off in January 2022, this is the tax period in which the increasing adjustment (of $100) would arise for the Recipient.
More likely is that the Recipient will have an increasing adjustment when the debt became overdue for more than 12 months.
Again, using the above example, the Recipient is treated as being aware that the debt became overdue for more than 12 months in April 2022, and this is the tax period in which the increasing adjustment (of $100) would arise for the Recipient.
Tax Invoices/Adjustment Notes
Under the GST rules generally, for an entity to claim GST back from the ATO they need to hold documentary evidence to support this claim. For a creditable acquisition, typically this is in the form of a Tax Invoice. Where a decreasing adjustment arises, e.g., where a transaction is cancelled or reversed, this is typically done in the form of an Adjustment Note.
However, where a decreasing adjustment arises under Division 21 there is no requirement to hold an adjustment note.
Recovery of Bad (or overdue) Debts
Having made a taxable supply, and subsequently written off the debt as bad (or the 12 months overdue rule has been applied), if any amount of the debt is actually recovered this triggers attribution of a further GST adjustment, but only to the extent of the amount recovered.
Using the examples from above:
- If after having written off the bad debt of $1,100 in January 2022 the Supplier recovers $550 in May 2022, then the Supplier would have an increasing adjustment of $50 in the May 2022 tax period/BAS (if monthly) or June 2022 tax period/BAS (if quarterly); or
- If after making the 12 months overdue adjustment in April 2022 the Supplier recovers $550 in May 2022, then the Supplier would have an increasing adjustment of $50 in the May 2022 tax period/BAS (if monthly) or June 2022 tax period/BAS (if quarterly).
If prior to 30 June you are reviewing your accounts receivable list to determine which debts may be bad, and if so to be written off, take the time to review the full list to ensure you also identify any debts that may have become overdue for more than 12 months.
Equally, you should also be reviewing your accounts payable list, particularly if you have any debts overdue for more than months.