Bad debts for tax purposes
It is an unfortunate fact of business life that sometimes you will not be paid in full for work you have done.
When this happens you have incurred a bad debt, and it is a very frustrating experience. The silver lining to this situation is that there are some tax breaks that can come along with a bad debt.
The first thing you have to do is make sure that the debt can be officially considered as bad for tax purposes.
First, you cannot have 'forgiven' the debt which means it must still be formally recorded as an outstanding amount owing to you and unrecovered. It is also necessary for you to demonstrate that you have taken reasonable steps to recover the amount.
In some cases this may involve legal action, depending on the size and type of debt. You must also make a written record of the decision to write off the debt, prior to the end of the financial year.
If the amount owed has been included in your assessable income then you may be able to claim the bad debt as a tax deduction, thereby reducing your tax liability.
If you pay GST on an accruals basis, you may also be able to claim back a GST credit. If you have paid GST on a sale but did not end up receiving any payment for that sale then you are able to adjust your BAS accordingly. You can make the adjustment to your BAS in the period when the debt was written off, or twelve months after the debt became due (whichever is relevant to your situation).
If you have written off part of a debt as bad, but recovered part of the amount, then you are able to claim a tax deduction on that portion of the debt. The same concept applies for GST adjustments.
The writing-off of a bad debt does not necessarily require highly technical accounting entries. It is sufficient that some form of written record is kept to evidence the decision of the taxpayer to write off the debt from the accounts.