A Guide to Bad Debt Relief Under UAE VAT Regulations

A Comprehensive Guide to Bad Debt Relief Under UAE VAT Regulations

In the world of business, credit transactions are the norm. While they facilitate trade and growth, they also carry an inherent risk: the possibility of non-payment. When a customer fails to pay an invoice, it creates a “bad debt,” a direct blow to a company’s revenue and cash flow. Under the UAE VAT system, this problem is compounded. Because VAT is accounted for on an accrual basis, a business must declare and pay output VAT to the Federal Tax Authority (FTA) at the time an invoice is issued, regardless of whether the customer has paid. This can lead to a painful scenario where a company has paid tax to the government on money it has never actually received.

Fortunately, the UAE VAT legislation provides a specific remedy for this situation: the Bad Debt Relief scheme. This mechanism allows a supplier to recover the output VAT they previously paid on a supply that has since turned into a bad debt. However, this relief is not automatic. The FTA has established a set of six strict, mandatory conditions that must be met before a business can make a claim. Failure to adhere to any one of these conditions can result in the rejection of the claim and potential penalties. This guide provides a detailed walkthrough of the Bad Debt Relief scheme, explaining the conditions, the process, and the critical documentation required to successfully reclaim your VAT.

Part 1: The Accrual Basis Problem – Why Bad Debt Relief is Necessary

To understand the need for bad debt relief, one must first grasp how VAT is accounted for. UAE VAT operates on an accrual basis. The “tax point,” or the moment VAT becomes due, is typically the earliest of the following:

• The date the invoice is issued.
• The date the goods are delivered or services are completed.
• The date payment is received.

For most business-to-business transactions, the tax point is the date the invoice is issued. This means the supplier is legally obligated to report the output VAT on their next VAT return and pay it to the FTA, even if their payment terms are 30, 60, or 90 days.

An Illustrative Example

Imagine ‘Supplier A’ provides consulting services to ‘Customer B’ and issues an invoice for AED 100,000 + 5% VAT (AED 5,000) on January 15th. The payment term is 60 days.

1. VAT Declaration: Supplier A files their Q1 VAT return and declares the AED 5,000 as output tax, paying it to the FTA by the due date.
2. Input Tax Claim: Customer B, who is also VAT registered, receives the invoice and claims the AED 5,000 as input tax on their own Q1 VAT return, reducing their tax liability.
3. Non-Payment: Customer B faces financial difficulties and ultimately goes out of business without ever paying the AED 105,000 invoice.

In this scenario, Supplier A has lost the AED 100,000 in revenue and is also out-of-pocket for the AED 5,000 in VAT paid to the government. Meanwhile, Customer B has benefited from a AED 5,000 reduction in their tax bill. The Bad Debt Relief scheme is designed to correct this imbalance.

Part 2: The Six Golden Rules – Conditions for Claiming Bad Debt Relief

Article 64 of the VAT Executive Regulations lays out the six conditions that a supplier must satisfy to claim bad debt relief. These are not guidelines; they are mandatory requirements.

Condition 1: Goods and Services Have Been Supplied and VAT Accounted For

This is the foundational condition. The supplier must have genuinely made a taxable supply of goods or services and have correctly charged VAT on it. Furthermore, this output VAT must have been declared on a previous VAT return and paid to the FTA. You cannot claim relief on VAT you have not yet paid.

Condition 2: The Consideration Has Been Written Off

The supplier must formally write off the debt from their financial records. This is more than just marking an invoice as “overdue.” It requires a specific accounting entry to move the amount from ‘Accounts Receivable’ to a ‘Bad Debt Expense’ account. This demonstrates to the FTA that the company has officially recognized the amount as irrecoverable. Proper account reconciliation and bookkeeping are vital for this step.

Condition 3: More Than Six Months Have Passed Since the Date of Supply

A supplier cannot immediately claim relief. A period of at least six months must have elapsed from the date of the supply. This waiting period ensures that the supplier has made reasonable efforts to collect the debt before deeming it “bad.” The clock starts from the date of supply (usually the invoice date), not the payment due date.

Condition 4: The Supplier Has Notified the Debtor

The supplier must take the proactive step of notifying the debtor (the customer) of their intention to write off the debt and claim VAT relief. This notification serves a dual purpose: it acts as a final collection attempt and officially informs the debtor of their own obligation to adjust their input tax (see Part 4). Evidence of this notification (e.g., registered mail receipt, email with delivery confirmation) is crucial for an FTA audit.

Condition 5: The Recipient Has Not Recovered the Input Tax (or has adjusted it)

This is often the most challenging condition. The supplier must be satisfied that the debtor has not claimed the input tax on the unpaid invoice. In practice, this is difficult to confirm directly. However, the notification in Condition 4 puts the onus on the debtor. If the debtor received the notification and fails to adjust their input tax, the supplier has fulfilled their obligation by informing them. If the debtor is not VAT registered, this condition is automatically met.

Condition 6: Maintain Sufficient Records

The burden of proof lies with the supplier. They must maintain a comprehensive set of records to demonstrate that all the above conditions have been met. This is where meticulous financial reporting and documentation are critical.

Part 3: How to Claim the Relief – The Practical Steps

Once all six conditions are met, the supplier can proceed with the claim.

1. Make the Accounting Entry: Your accountant or CFO service provider should record the journal entry to write off the debt.
2. Send the Notification: Dispatch a formal letter or email to the debtor.
3. Adjust Your VAT Return: The relief is claimed by making an adjustment in the VAT return for the period in which the conditions were met. You must reduce the figure in ‘Box 1: Standard Rated Supplies’ for the relevant emirate by the net value of the bad debt. This negative adjustment will automatically reduce your calculated output tax for the period, effectively refunding you the VAT.

Part 4: The Other Side of the Coin – The Debtor’s Obligation

The Bad Debt Relief scheme has a corresponding obligation for the debtor. If a VAT-registered customer has claimed input tax on an invoice but has failed to pay it for over six months, they are required to reduce their input tax claim. They must make a negative adjustment in ‘Box 9: Standard Rated Expenses’ of their VAT return. This ensures the government’s tax position remains neutral.

Part 5: When the “Bad” Debt Gets Paid – Reversing the Claim

What if, after a supplier has claimed bad debt relief, the customer makes a full or partial payment? In this event, the relief must be reversed.

• Supplier’s Duty: The supplier must make a positive adjustment on their next VAT return to repay the corresponding portion of the VAT relief they received.
• Debtor’s Right: The debtor, upon making the payment, is then entitled to reclaim the corresponding input tax.

Managing the Process with Robust Accounting Systems

Tracking invoice aging, identifying potential bad debts, managing write-offs, and ensuring the correct VAT adjustments are made can be an administrative nightmare without the right tools. This is why a modern, cloud-based accounting system like Zoho Books is indispensable. It provides a clear view of your accounts receivable, automates reminders, and allows you to easily tag and record write-offs, creating a clear audit trail that is essential for substantiating a bad debt relief claim to the FTA.