Unpaid invoices: beware of the tax deductibility of bad debts

A customer is considered doubtful when, despite several reminders, he or she does not come forward and the invoice remains unpaid. There is therefore some doubt as to the customer's intention or ability to pay. A receivable is a sum of money still owed by a customer following the delivery of goods or services. It is due on a specific date. If the due date has passed, and reminder letters are unsuccessful, the chances of recovering payment are diminished. The receivable is then called doubtful and should be recorded as such, i.e. by setting aside a provision for doubtful debts, which will be deductible from income. But beware of tax deductions for doubtful debts, which can only be made under certain conditions.

When is a debt considered doubtful?

In the eyes of the tax authorities, the term "doubtful debt" is used only when, in the presence of a claim that is certain, liquid and due, collection seems uncertain.

The claim must be certain, i.e. its existence can be proven by a supporting document such as an invoice, and it must not be disputed by the debtor. Otherwise, it would be a disputed claim. The claim must be liquid, i.e. the price must be clearly stipulated on the supporting document. Finally, the claim must be due and payable, as the legal payment deadline has passed.

Why set aside provisions for doubtful debts?

Unless proof is provided that the debtor will never pay the invoice, as is often the case in bankruptcy, the claim remains doubtful. If it is definitively lost, it becomes an irrecoverable debt and will be written off in the accounts.

In the meantime, the company records a provision. Recording provisions means that debts of this kind can be deducted from taxable income, and so pay less tax. The purpose of provisions is to anticipate the charge that would result from non-payment. In the event of doubtful debts not being taken into account, the company would pay taxes on a revenue that has not been collected.

However, this is not a practice to be repeated too often, as the tax authorities do not always accept provisions.

Before provisioning, the receivable must appear in the assets and not be disputed. Only if these two conditions are met is a tax deduction possible. In addition, the company may be required to prove that recovery of the debt is in jeopardy and that the loss is potential.

Why pay attention to tax deductions?

Every year, at the close of the financial year, whenever an asset loses value, an entry for depreciation must be made. In the case of receivables, the entry will correspond to the portion considered potentially irrecoverable. If, for example, it is established the following year that the debtor will never settle his debt, the depreciation will have to be reversed and the receivable written off.

For a provision or loss to be deductible, it must not only be properly accounted for and justified, but must also be set up to cover an expense that is itself deductible.

In the event of a proven loss, VAT recovery is authorized, but only if the company can provide proof of the irrecoverable nature of the debt, in particular by showing what procedures it has used to try to recover what it owes. A certificate of irrecoverability will then be issued.

If the tax authorities consider that the recording of a provision or loss is unjustified, they can call the depreciation into question at any time and reinstate the amount in the profit and loss account for the year, with a tax adjustment in addition.