Can I claim bad debts as an allowable expense?

Understanding what “bad debts” means in a business context

Bad debts are amounts that your business expected to receive, but ultimately will not. In plain terms, it is money owed to you by a customer, client, tenant, or other debtor that has become irrecoverable. Most commonly, bad debts arise when you sell goods or services on credit, issue an invoice with payment terms, and the customer either cannot or will not pay. Over time, you may chase the debt, attempt to negotiate, or even take legal action—yet still end up with nothing. When that happens, the unpaid amount may be classed as a “bad debt.”

Businesses ask an important tax question at this point: can that loss be claimed as an allowable expense, reducing taxable profit? The short answer is often “yes, sometimes,” but it depends on the nature of the debt, how it arose, and whether you can demonstrate that it is truly irrecoverable. The tax rules typically aim to allow relief where the debt is connected to taxable business income, while blocking relief where the “debt” is really a loan, a capital investment, or a private arrangement.

This article explains how allowable expense relief for bad debts generally works, how to determine whether a debt qualifies, what evidence is usually expected, how VAT considerations may interact, and how to record and report bad debts in a way that makes sense for both accounting and tax.

What does “allowable expense” mean, and why does it matter?

An allowable expense is a business cost that can be deducted when calculating taxable profit. In most tax systems, the basic idea is that you should be taxed on profit, not turnover. If you made sales of 100, had costs of 60, and ended up with net profit of 40, the taxable base should generally be 40, not 100. Bad debts fit into this logic because they represent income you thought you had earned, but did not actually receive.

However, tax rules rarely allow relief for just any loss. They typically require that the expense (or loss) is incurred for business purposes, and that it is not capital in nature. A bad debt is usually treated like a revenue expense or adjustment, not a capital loss, provided it relates to day-to-day trading income and is properly reflected in the accounts.

Understanding this difference is crucial. If the unpaid amount arose from trading—such as a customer invoice for goods or services you supplied—bad debt relief is more likely. If it arose from lending money to someone, funding another business, or making a deposit that is more like an investment, relief may be restricted or treated differently.

When can a bad debt usually be claimed as an allowable expense?

Most businesses can claim a deduction for bad debts where the debt is closely linked to taxable trading income and has been included as income in the first place. The logic is simple: if your accounts show a sale and you pay tax on that profit, you should not be taxed on money you never receive. So, if you have recorded the income, and later it becomes clear you will not receive it, you adjust your accounts by writing it off as a bad debt.

In many cases, the key requirements look like this:

First, the debt must arise from your normal trade or business activity. If you invoice a customer for services, that is a trading debt. If you loan money to a friend, even if you run a business, that is typically not a trading debt (unless you are in the business of lending money as part of your trade).

Second, the amount must have been treated as business income. A debt that was never counted as income cannot usually be deducted as a bad debt expense because you never paid tax on it in the first place. For example, if you run a cash-based system and only record sales when paid, unpaid invoices generally would not be included as income, so there may be no corresponding deduction when they are not paid. The accounting method you use affects how the relief works.

Third, the debt must be “bad,” meaning it is genuinely irrecoverable. This does not mean you must exhaust every possible route to recovery, but you should take reasonable steps and have a sensible basis for concluding it will not be paid. If there is still a realistic prospect of collection, tax authorities may argue the debt is not yet bad, and a write-off is premature.

Fourth, the write-off should be properly recorded in your books and records. It is not enough to merely “decide” a debt is bad. Usually, you must make an accounting entry that reduces receivables and recognizes a bad debt expense (or recognizes an impairment, depending on your accounting framework). The accounting evidence is often central to the tax position.

Trading debts vs. loans: the distinction that decides many cases

One of the most common misunderstandings is assuming that any unpaid amount can be claimed as a bad debt. Tax relief is typically focused on trading debts—amounts owed from customers arising from sales made in the ordinary course of business. Loans are different. If your business lends money to someone and they do not repay, that is often treated as a capital loss or a non-trading matter, and may not be deductible against trading profit in the same way.

Consider these examples:

If you are a marketing agency and you invoice a client 5,000 for a campaign, the client goes into liquidation, and you receive nothing, that is usually a straightforward trading bad debt (subject to proper evidence and accounting).

If you are the same agency but you loan 5,000 to the client to help them “stay afloat,” and they fail and cannot repay, that is generally not a trading bad debt. It is a loan. Unless you are in a trade where lending is part of your ordinary business, the tax treatment may be less favorable, and relief may be limited or fall under different rules.

If you pay a supplier a deposit for goods and the supplier disappears or becomes insolvent, your loss may be deductible as a business expense in some contexts, but it is not always treated as a “bad debt” in the strict sense, because the supplier did not owe you a trade receivable in the same way a customer does. It might be treated as a loss or expense connected to trade, but classification matters.

In short, the label “bad debt” should match the underlying reality. The closer the unpaid amount is to ordinary trading income, the more likely it will be treated as an allowable deduction as a bad debt.

What makes a debt “bad” rather than merely “late” or “doubtful”?

Businesses often have overdue invoices. Not every overdue invoice is a bad debt. A debt usually becomes “bad” when there is no reasonable expectation of recovery. Some accounting frameworks distinguish between “doubtful” debts (where some risk of non-payment exists) and “bad” debts (where recovery is no longer expected). For tax purposes, the key is typically whether the debt has been written off as irrecoverable, rather than merely provided for as a general estimate.

Many systems do not allow a tax deduction simply for creating a general provision like “5% of debtors might not pay.” A broad estimate is often disallowed because it is not specific enough. By contrast, a specific write-off of a named customer balance that is demonstrably irrecoverable is more likely to be allowed.

Indicators that a debt may be bad include:

The customer is insolvent, has entered bankruptcy, liquidation, or administration, and you have evidence that there will be little or no distribution to creditors.

You have taken reasonable recovery steps (reminders, final demand, negotiations, payment plans), but the customer has ceased communication or has explicitly stated they cannot pay.

A court judgment has been obtained but cannot be enforced because the debtor has no assets, or enforcement has failed.

A debt collection agency has reported the debt as uncollectable after attempts.

The debtor has disappeared and cannot be traced, despite reasonable steps.

It is not always necessary to reach a formal legal endpoint, but you should be able to show why you concluded the debt is irrecoverable at the time you wrote it off.

The importance of your accounting method: accruals vs. cash basis

Whether you can “claim” bad debts as an allowable expense often depends on how you recognize income. Two common approaches are accruals accounting and cash basis accounting.

Under accruals accounting, you recognize income when it is earned and invoiced, not when it is paid. This means unpaid invoices are included in revenue. If you later determine an invoice will not be paid, you recognize a bad debt expense (or impairment) to reflect the loss. Because income was previously recognized, the deduction typically makes conceptual sense: you are reversing revenue that will never be realized.

Under cash basis accounting, you recognize income when money is received. If you never receive payment, the sale might never be included in taxable income. In that scenario, you might not need a bad debt deduction because you were never taxed on the unpaid amount in the first place. That said, some systems have special rules, and some businesses use hybrid approaches. The practical takeaway is that you should align your expectations of tax relief with your method of accounting.

If you are unsure which method you use, check how you record sales: do you book invoices as income immediately, or only record income when money hits the bank? Your bookkeeping software settings, your year-end accounts, and your tax return approach will usually reveal this.

Evidence and documentation: what you should keep

Because bad debt deductions reduce taxable profit, they are a common area of challenge. Good documentation is your best protection. You generally want to keep records that show:

The original invoice or contract, proving the debt arose from a genuine supply of goods or services.

Correspondence with the customer: reminders, statements, emails, letters, or messages requesting payment.

Notes of phone calls or meetings, including dates and outcomes.

Any payment plans agreed, and evidence of default on those plans.

Debt collection or legal documents, if used: letters before action, court filings, judgments, enforcement attempts, or collection agency reports.

Evidence of insolvency, if relevant: notices of liquidation, bankruptcy filings, administrator communications, or creditor updates.

The accounting entry showing the write-off (and the date it was recognized).

The goal is not to create paperwork for its own sake. The goal is to show a clear story: this was a real trading debt, you tried to collect it, and as of a particular date it became reasonable to conclude it would not be paid.

Partial recoveries and negotiated settlements

Sometimes a debt is not fully bad. You might recover part of it, or you might agree a settlement. For example, a customer owes 10,000, but after disputes and negotiations they agree to pay 6,000 as full and final settlement. In that case, the remaining 4,000 may be treated as a loss. The exact accounting treatment depends on why the shortfall arose (for instance, a discount granted, a dispute resolution, or a write-off due to inability to pay), but from a tax perspective it is often still connected to trading income.

Similarly, if a customer goes insolvent and you receive a small dividend from the liquidation, you typically write off the balance that will not be paid. You may also need to adjust if, unexpectedly, you receive additional distributions later.

A practical rule to follow is: claim relief only for the amount you genuinely do not expect to recover, and update your records if you later recover more than expected. That helps ensure your profit reporting remains accurate and defensible.

What happens if you later recover a debt you wrote off?

It does happen: a debt is written off, and then the customer pays unexpectedly, or a liquidator distribution arrives years later. In most tax systems, a recovery of a previously written-off bad debt is treated as taxable income in the period you receive it (or in the period you reinstate it in the accounts). This prevents double benefit: you cannot deduct the loss and also keep the later recovery tax-free.

From a bookkeeping standpoint, you would typically record the money received and credit it to bad debt recoveries or a similar income account. The idea is to keep the audit trail clear: this was previously written off, but it has now been recovered in whole or in part.

Bad debts and VAT: a common point of confusion

Where VAT applies, bad debts can create a second layer of relief. If you charged VAT on a sale and accounted for that VAT to the tax authority, but later never receive the customer payment, you may be able to claim VAT relief on the bad debt—subject to conditions. The detail varies by jurisdiction, but the concept is that you should not be out of pocket for VAT on a sale that was never paid.

VAT bad debt relief often comes with specific requirements, such as time limits, evidence of write-off, and proof that the customer is not connected or that the debt is not disputed. It may also require that the VAT has already been paid to the authority and that the debt has remained unpaid for a minimum period. Some jurisdictions also require that you do not later “forgive” the debt in a way that is really a discount or a credit note without following proper VAT procedures.

Even if you are not focused on VAT, it is worth noting that VAT and income tax/corporation tax treatments can differ. You might be able to claim a trading bad debt deduction but have separate steps for VAT relief, or vice versa. Keeping your bookkeeping tidy and clearly marking the status of invoices helps avoid errors.

Bad debts for different business structures: sole traders, partnerships, and companies

The underlying concepts are broadly similar across business structures: a trading bad debt that was previously recognized as income and later written off is commonly deductible in calculating taxable profit. However, the reporting mechanics and detailed rules may vary depending on whether you are a sole trader, a partnership, or a limited company.

For sole traders and partnerships, the bad debt usually reduces the taxable profit of the trade. For companies, the bad debt typically reduces the company’s taxable profits for corporation tax purposes. In all cases, the key is usually that the debt relates to the trade, is properly recognized in accounts, and is genuinely irrecoverable.

Some additional complexities can arise for closely held businesses where the “debtor” is related to the owner, a director, an employee, or another connected party. In connected-party scenarios, tax rules often tighten to prevent abuse, such as writing off informal loans and claiming deductions. If the debtor is connected, it is especially important to document that the amount arose from genuine trading (for example, a real invoice at market value) rather than being a disguised distribution or personal arrangement.

Connected parties and “friendly” write-offs: proceed carefully

Writing off a debt owed by a friend, a family member, or a connected business can attract scrutiny. Tax authorities generally want to ensure that write-offs are commercially justified and not a way to shift profits artificially. If you routinely forgive debts for connected parties, it may be argued that the “debt” was never truly intended to be collected, or that the transaction was not on normal commercial terms.

That does not mean connected-party bad debts are automatically disallowed. It means you should be prepared to show that:

The sale was genuine and part of your trade.

The price and terms were commercial and consistent with how you treat other customers.

You made reasonable efforts to collect, similar to your normal credit control process.

The debtor’s inability to pay is real and evidenced, not simply a preference not to pay.

The write-off decision is consistent with prudent business practice.

If you cannot show those things, the deduction may be challenged.

Disputed invoices: when the issue is not “bad debt” but “sales adjustment”

Sometimes non-payment is not due to inability to pay, but due to a dispute about what was supplied. Perhaps the customer claims the work was defective, incomplete, or not delivered. In such cases, the correct treatment may be different from a bad debt write-off. If you agree the customer has a valid complaint, you might issue a credit note or reduce the invoice. That is less a “bad debt” and more a correction to revenue because the original sale value was overstated.

If the customer simply refuses to pay despite there being no valid dispute, that is closer to a bad debt scenario. But if a dispute is genuine and unresolved, treating it as a bad debt can be premature. Many businesses separate these situations in their accounting: one category for disputed items (potential credits or adjustments), another for clear bad debts (uncollectable amounts).

How to decide the right time to write off a bad debt

Timing matters because deductions are usually taken in the period the debt is written off or becomes irrecoverable. If you write off too early, it may be challenged. If you write off too late, you might delay relief unnecessarily. The “right” time is generally when, based on the evidence available, it becomes reasonable to conclude that collection is unlikely.

Practical triggers that often lead to write-off decisions include:

A formal insolvency event where you are informed there will be no return to unsecured creditors.

Repeated failed collection attempts over a meaningful period, with no engagement from the debtor.

Legal advice indicating enforcement would be uneconomic or impossible.

A clear internal credit control policy, such as writing off debts older than a certain age when specific steps have been taken (for example, reminders at 30/60/90 days, final demand, and then write-off at 180 days if no response).

Having a documented policy is helpful because it shows consistency and commercial rationale. But you still need to ensure the policy reflects reality. For high-value debts, a longer process may be expected. For low-value debts, it may be reasonable to stop chasing sooner if collection costs would exceed recovery.

Common bookkeeping entries for bad debts

From an accounting standpoint, writing off a specific bad debt typically involves removing it from accounts receivable and recognizing an expense. The exact accounts depend on your chart of accounts, but conceptually it looks like this: debit bad debt expense (or impairment expense), credit accounts receivable (trade debtors) for the amount being written off.

If you use an allowance method (sometimes called a provision for doubtful debts), you might first recognize an impairment allowance and then write off against that allowance. Some tax regimes allow certain impairment approaches; others focus strictly on specific write-offs. In any case, your end result should clearly show which customer balance was written off and when.

The quality of your records matters. A vague journal entry that does not identify the debtor, the invoice, or the rationale can be harder to defend than a write-off processed through your invoicing system, linked to the original documents.

Industry-specific examples of bad debt claims

Bad debt scenarios differ by industry. Looking at examples can help you map the principles to your situation.

A tradesperson completes work for a homeowner and invoices 2,000. The homeowner delays payment for months and then moves away. After letters and attempts to contact, the tradesperson concludes the debt is uncollectable. If the invoice was included as income under accruals accounting, a bad debt write-off may be allowable.

A software consultancy invoices a corporate client 20,000. The client enters administration. The administrator confirms unsecured creditors will receive nothing. The consultancy writes off the receivable. This is a classic trading bad debt, assuming the sale was genuine and recorded as income.

A retailer sells goods on account to a small business customer. The customer disputes the goods were delivered, but the retailer has signed delivery notes and tracking data. The retailer pursues the claim, but enforcement costs would be high and the customer appears insolvent. If the retailer decides the debt is irrecoverable, a write-off may be appropriate, but documenting the delivery evidence and collection steps becomes especially important.

A landlord running a property rental business faces unpaid rent from a tenant who leaves owing three months’ rent. Whether that unpaid rent is treated as a bad debt depends on how the rental activity is treated for tax purposes and the accounting method used. In many cases, unpaid rent that was recognized as income but not collected may be deductible, but rules for property income can differ from rules for trading income.

Bad debts for cash sales and card chargebacks

Not all losses that “feel like” bad debts are actually debts owed by a customer. If you normally sell for cash or card, you might not have receivables in the same way. But you might still face losses, such as chargebacks, fraud, or payment reversals.

Card chargebacks can occur when a customer disputes a payment and the payment provider reverses the transaction. If you already recognized the sale as income and the money is removed, you typically record the reversal as a reduction of sales or as an expense, depending on your accounting presentation. Whether it is called a bad debt or a chargeback expense, the commercial reality is a trading loss connected to revenue, and it is often deductible when properly recorded.

Fraud losses can also arise if a transaction is reversed or if goods are delivered and payment is later found to be fraudulent. Again, classification matters: it may be a trading loss rather than a bad debt, but the tax principle of allowing genuine business losses often applies, subject to the rules in your jurisdiction.

What is usually not allowed as a “bad debt” deduction?

While rules differ, there are common categories that are often restricted or disallowed as bad debt deductions:

Personal loans made by the business owner that have no clear trading purpose.

Amounts that were never included as taxable income because you use a cash basis.

General provisions or broad estimates that are not tied to specific debts.

Debts that are “forgiven” for non-commercial reasons, particularly with connected parties, where it looks like a gift or distribution rather than a genuine loss.

Capital-type losses, such as investments that fail, deposits that are more like capital contributions, or amounts advanced to acquire assets, unless specific rules provide relief.

Penalties, fines, or amounts arising from illegal activity are often non-deductible as a matter of public policy, and trying to dress them as bad debts will not help.

The consistent theme is that tax relief is aimed at genuine trading losses, not private generosity or investment failures.

Practical steps to maximize the chance your claim is accepted

If you want the best chance that a bad debt will be treated as an allowable expense, focus on clarity, consistency, and evidence.

Use written credit terms and issue proper invoices. A clear paper trail makes it easier to show the debt is real.

Maintain a standard credit control process. Send reminders on a schedule, keep notes, and apply similar steps to all customers. Consistency helps show commercial behavior.

Separate disputes from bad debts. If an invoice is disputed, document the dispute and the resolution. If it is uncollectable, document the collection steps and the write-off decision.

Write the debt off in your accounting system with an identifiable audit trail. Link the write-off to the invoice and customer.

Keep insolvency and legal documents where relevant. If you rely on insolvency as the reason, keep the notice and any creditor communications.

Review old debts periodically. If you never review receivables, you may end up carrying unreal amounts for years and missing the appropriate period for write-offs.

Be cautious with connected parties. Treat them like any other customer, and ensure transactions are commercial in nature.

How bad debt claims can affect your financial statements and decision-making

Bad debt accounting is not only about tax. It also affects how you understand the health of your business. High levels of bad debts can signal issues with customer quality, credit terms, pricing, contract clarity, or collection processes. Writing off bad debts cleans up your balance sheet, but it can also prompt better practices.

Common improvements businesses make after reviewing bad debts include:

Requiring deposits or upfront payments for new customers.

Reducing payment terms from 60 days to 30 days.

Using staged payments tied to milestones.

Adding stronger contract terms around non-payment and interest.

Performing credit checks on larger clients.

Using automated reminders and clearer invoicing.

While these measures cannot eliminate all bad debts, they can reduce the frequency and severity, which helps both cash flow and profitability.

Frequently asked questions about claiming bad debts as an allowable expense

Do I need to take the debtor to court to claim a bad debt? Not necessarily. Many tax systems only require reasonable steps to recover the debt, not maximal steps. If court action would be uneconomic, you can often justify a write-off without it, especially for smaller amounts. However, for large debts, more substantial recovery efforts may be expected.

Can I claim a deduction if I simply decide not to chase the customer? If you choose not to chase a customer for commercial reasons, you need to be careful. If the debt is genuinely irrecoverable, your decision may be justified. But if it appears you are forgiving the debt without a strong reason, the deduction may be challenged. Document why it was not practical to pursue further.

What if the customer is slow but eventually pays? If the debt is still likely to be paid, it is not usually a bad debt. You might monitor it as overdue or doubtful. If you write it off and later get paid, you would generally treat the recovery as taxable income in the year you receive it.

What about small debts that are not worth chasing? Many businesses write off small balances when the cost of collection exceeds the likely recovery. That can be commercially reasonable. The key is to have a policy and apply it consistently, and to keep enough documentation to show the debt was real and the write-off was a business decision.

Can I claim bad debts on unpaid interest or late fees? If you charge interest or late fees and recognize them as income, and they later become uncollectable, they may be treated similarly to other trading receivables. But if you never recognized them as income, a deduction may not be relevant. The treatment can also depend on whether the charges are truly part of trading income.

Checklist: a simple way to test whether your bad debt is likely allowable

Before you treat a bad debt as an allowable expense, run through this checklist:

Did the debt arise from your ordinary business trading activity?

Was the amount included in your income under your accounting method?

Do you have a clear invoice or contract supporting the debt?

Have you taken reasonable steps to collect it?

Do you have evidence that it is now irrecoverable?

Have you written it off properly in your accounting records?

If you can answer “yes” to all of these, the position is generally much stronger.

Conclusion: so, can you claim bad debts as an allowable expense?

In many cases, yes: if a customer owes you money from normal trading, you have recognized that income, and you can show the debt has become genuinely irrecoverable, then writing it off is commonly treated as an allowable expense that reduces taxable profit. The decisive factors are usually the nature of the debt (trading vs. loan or capital), the accounting method you use, and the evidence you keep to support the write-off.

The most reliable approach is to treat bad debts as a normal part of disciplined financial management: invoice clearly, chase consistently, document everything, and write off only when it is commercially reasonable to conclude you will not be paid. Done properly, the tax relief follows the underlying business reality—profit should reflect what you actually earn, not what you hoped you would earn.