How to recover VAT from unpaid invoices?

Do I have to pay VAT on unpaid invoices?

When the time for submitting and paying your VAT return comes, you must include and pay the tax authorities those VAT amounts collected from your customers during that VAT return period. Even if you have yet to receive the invoice payment from your customer, you must declare and pay the VAT amounts charged during the reporting period to the tax authorities.

You will report these unpaid invoices in the VAT return period corresponding to the invoice date. There are some deviations from this rule. To know the exact timing of your reporting obligations, you can look at the tax point rules applicable in each country.

Tax point rules determine the time when VAT becomes due. Transactions should be reported in the VAT return of the period when the tax point occurred. In Europe, some countries take the invoice date as the tax point date, while others take the moment when the service is completed, or the goods are put at the customer’s disposal as the tax point date. Some jurisdictions combine both, invoice date and completed transaction.

Also, VAT due should be distinguished from VAT payable. VAT becomes due when the tax point occurs, VAT is payable between the first day after the reporting period and the due date to make the VAT payment in each country.

This means, you must include in your VAT return all the transactions for which VAT became due during the reporting period, and pay the VAT within the statutory deadline, even if you have not collected this VAT amount from your customer.

Unpaid invoices generate a breach of the neutrality principle of VAT: taxpayers must pay a VAT amount that was never collected from the customer, becoming a cost for the supplier. Also, paying the VAT from unpaid invoices aggravates the cash flow situation for the taxpayer, who already needs to deal with a customer that did not pay the supply made.

How do I claim VAT back on unpaid invoices? VAT bad debt relief

Most countries in Europe have a bad debt relief scheme allowing taxpayers to deduct  output VAT previously paid to the tax authorities from unpaid invoices.

Conditions and timelines vary from one country to another. Some countries are more flexible allowing taxpayers to directly deduct the VAT on bad debts in VAT return upon few conditions, while others impose strict requirements and establish a specific procedure to go through before being able to deduct VAT on unpaid invoices. 

European Union Member State countries may implement bad debt relief schemes. Article 90 from the EU VAT Directive (Directive 2006/112/EC) allows Member States to implement in their legislation mechanisms to allow suppliers reduce the value of their taxable turnover concerning transactions where the customer has not paid in full or in part the price of the service or the good (bad debt relief). Some examples of EU countries that have introduced the bad debt relief scheme are: Belgium, Austria, Spain or Germany. An example of an EU country that does not allow bad debt relief is Bulgaria.

Also, other European countries have similar mechanisms. This is the case of the United Kingdom, which kept the bad debt relief scheme after Brexit. The UK has a rather flexible bad debt relief regime in comparison with other EU countries.

Requirements for recovering VAT on an unpaid invoice

Requirements and conditions vary among countries where the bad debt relief scheme exists.

These are some of the most usual conditions and requirements:

• There is a fully or partly unpaid invoice.
• The supplier already declared and paid the correspondent output VAT to the tax authority.
• The supplier took reasonable steps to reclaim the unpaid invoice to the debtor.
• The debt remains outstanding after a specific time period.
• There is evidence that the debt is irrecoverable, and that the customer has no financial resources to pay the debt. In some countries, like Sweden or Spain, the supplier must be able to prove these circumstances.
• The debt amount was written off from the accountancy, and a credit note was issued. Some countries also establish specific time frames for issuing credit notes.

For example, in the United Kingdom, the VAT amounts that are not collected from the customer but were paid as output VAT to the tax authorities can be recovered when the following specific conditions are met:

1. six months passed since the issuance of the invoice,
2. the debt was written off in the business accounts,
3. the price is not higher than the customary selling price,
4. and the debt was not sold or factored under a valid legal assignment.

Find here the official guidelines on the bad debt relief scheme issued by the HMRC.

As a second example we can take Belgium, an EU country. The refund of VAT from unpaid invoices is only possible in the following scenarios:

• Bankruptcy or insolvency of the customer, or the supplier can prove that the debt was claimed to the debtor by all possible means.
• The taxpayer must always issue a credit note including a specific wording.

You can find more information about the conditions and procedure of bad debt relief in Belgium in the specific section from our Belgian manual.

Finally, as a third example, Spain. Unlike the UK, the Spanish bad debt relief scheme is quite cumbersome and strict. You can check here some of the conditions to claim VAT on bad debts in Spain.

Steps to recover VAT from unpaid invoices

Similarly, the procedure for reclaiming the VAT from unpaid invoices varies country by country.

The common approach is to include the output VAT previously paid as deductible in the VAT return. In some countries you need to submit corrective VAT returns for the reporting period where the irrecoverable VAT was reported, while in other countries you just need to deduct the VAT amount in the following reporting period when you meet the conditions to recover the VAT on bad debt.

Also, depending on the country you may directly deduct the VAT in the VAT return when you verify meeting all conditions, however, in other countries you need to go through a procedure where the tax authorities verify the relevant conditions are met.

Following the example of the United Kingdom bad debt relief scheme, VAT on bad debt can be claimed directly in the next VAT return once the conditions have been met. To do so, you should include the amount of the VAT you’re claiming in box 4 of your VAT Return which covers the date when you fulfill the conditions to make a claim. There are no additional formalities to be met (e.g. no credit notes, corrective returns, or letters to the authorities are not required). Separately, you must keep a copy of the VAT invoices containing the VAT on the bad debt you are claiming, as well as a separate bad debt account.

In Belgium and Spain, the VAT from unpaid invoices is also claimed via the VAT return, however, you must always issue a credit notes, and also you need to go through specific procedures to finally be able to deduct the VAT.

Deadline to claim VAT refunds for unpaid invoices

Usually, countries establish a deadline to claim VAT refunds for unpaid invoices. The most common approach is that you must include the VAT on bad debts within the reporting period where the bad debt arises, i.e., when you meet all conditions to consider the VAT from your unpaid invoices as irrecoverable bad debt.

Separately, if the VAT return submitted is in a credit position, you may also want to check the country rules for requesting a VAT refund via the VAT return.