Do you need to make an adjustment for unpaid invoices?

Your business has some unpaid purchase invoices in the 90-day+ column of its aged creditors report. Input tax has been claimed on these invoices. Why does this lead to a problem and how could you avoid it in the future? Bob Johnstone from our Galashiels office investigates.

If you pay and claim VAT based on invoice dates, you need to be aware that input tax must be repaid to HMRC if an invoice is more than six months overdue for payment. This rule ensures that HMRC is not out of pocket because a supplier is entitled to claim bad debt relief on unpaid sales invoices that are more than six months overdue for payment and have been written off in the business accounts.

If an invoice is silent on the payment terms, the invoice date becomes relevant as far as the six-month adjustment date is concerned. You should check that none of the invoices on your aged creditors report are exempt from VAT or zero-rated where you would not have claimed input tax in the first place, i.e. you do not need to adjust under the six-month rule.

If you have to repay the VAT on your unpaid purchase invoices under the six-month rule but pay them at a later date, then you can reclaim input tax again on the return that coincides with the payment dates. It is possible that the payment only partly pays an outstanding invoice, in which case you will treat the payment as being inclusive of 20% VAT.

It is possible that you will receive credit notes from suppliers to reduce or cancel the value of the unpaid purchase invoices in the end column of your aged creditors report. You will reduce the input tax claimed on the original invoice when you process the credit notes. If you have already reduced your input tax under the six-month rule then you can reverse this when you receive a credit note from your supplier, otherwise you will be reducing your input tax twice.

One way around this type of problem is to use a special VAT accounting scheme. If your business uses the cash accounting scheme, then you will not have claimed input tax on any unpaid purchase invoices because input tax (and output tax) entries on a VAT return are based on payment dates. If you use the scheme you don’t need to worry about entries on your aged creditors report.

You can adopt the cash accounting scheme if you expect your taxable sales will be less than £1.35 million excluding VAT in the next twelve months.

In general, input tax must be repaid to HMRC if the invoice it relates to is unpaid more than six months after its due date. If you pay the invoices later, don’t forget to claim the input tax again. Consider adopting the cash accounting scheme if you are eligible to do so, as you won’t claim input tax until you actually pay it, therefore removing the issue.