One of the general housekeeping matters as part of financial year end tax planning is reviewing debtors to determine whether there are any bad debts. Provided the debt is actually bad and is written off before 30 June, a taxpayer in business will be able to claim the bad debt as a deduction.
A further consequence of writing off the bad debt is that it generally gives rise to GST adjustments.
Consider a simple example where an entity (the supplier) has made a taxable supply to a customer for $1,100 inclusive of GST. Assume the supplier issued a tax invoice dated 31 March 2015 with payment terms of 30 days. Unfortunately, the customer did not make payment within the payment terms and while the supplier attempted to collect the debt in the following months, as at 30 June 2015 the supplier continued to consider that the full debt was collectible. Accordingly, the debt was neither bad nor written off as at 30 June 2015. Despite continuing to seek collection of the debt the customer has failed to pay and the supplier is now considering whether to write the debt off as bad.
In the example, and assuming the supplier accounts for GST on a non-cash (accruals) basis, the supplier would have included the sale in its March 2015 BAS and the $100 of GST would have been paid to the ATO. As the supplier has not yet collected any of the debt, the supplier is out of pocket for the $100.
Division 21 of the GST law contains specific rules regarding bad debts. This division applies not only to debts that are written off as bad, but also to debts that are outstanding or overdue for at least 12 months.
With regard to bad debts the supplier would be entitled to a GST decreasing adjustment (that is, claiming an amount of GST back from the ATO) where the supplier made a taxable supply, the whole or part of the consideration for that supply has not been received, and the supplier has written off as bad the whole or part of the debt. The decreasing adjustment is calculated as 1/11th of the amount of the bad debt written off.
In terms of the example, provided the debt is bad and the whole debt has been written off, the supplier would have a GST decreasing adjustment of $100 (being 1/11th of the $1,100). This adjustment would be attributed to the tax period during which the debt is written off.
12 Months Overdue Debts
Even where a debt is not bad or has not been written off, similar GST adjustments arise where debts have become more than 12 months overdue. Even though a supplier may not have actually written off the debt as bad, and assuming no part of the debt has been collected, the supplier would be entitled to a GST decreasing adjustment where the debt is more than 12 months outstanding.
In the example, as the customer has 30 days payment terms the debt would be due for payment on 30 April 2015. Therefore, the debt only becomes overdue for 12 months or more as from 30 April 2016. Where this is the case, the supplier is entitled to a GST decreasing adjustment of $100 and can include this in the April 2016 tax period (if monthly this would be the April 2016 BAS, or if quarterly this would be the June 2016 BAS).
Division 21 also contains a corresponding GST increasing adjustment provision that applies to the customer. That is, if the customer is on a non-cash (accruals) basis, has made a creditable acquisition, the whole or part of the consideration is overdue and the customer has not provided the overdue consideration, and the debt is either written off as bad or becomes more than 12 months overdue, then a GST increasing adjustment arises to the customer. The increasing adjustment is calculated as 1/11th of the amount of the overdue debt and would be attributed to the tax period during which this adjustment is triggered.
Should the supplier subsequently recover any or all of a written off bad debt or a debt that is 12 months overdue, then this would give rise to a GST increasing adjustment to the supplier equal to 1/11th of the amount recovered. Similarly, a GST decreasing adjustment (equal to 1/11th of the amount paid) would arise to the customer to the extent that such a debt is actually paid.
It is good housekeeping to review all debts prior to year-end to determine if any are bad. Where bad debts are written off, don’t forget to also determine whether this gives rise to a GST decreasing adjustment. At the same time, even though a debt may not bad, if it is more than 12 months overdue this may also give rise to a GST decreasing adjustment claim.