Tax-deductible bad debt allowance

What it means

A tax-deductible bad debt allowance is an impairment allowance against a receivable that the Income Tax Act lets a business claim as a deductible expense. In the accounts a company records an allowance whenever there is a real risk of non-payment, but for tax it is recognised only in precisely defined cases.

The main criterion is how long the debt is overdue. For receivables falling due after 2014, 20 percent of the nominal value can be deducted after 360 days overdue, 50 percent after 720 days and the full amount after 1,080 days. If the debtor is in bankruptcy, the allowance is recognised up to the amount of the filed claim.

A condition is that the receivable was previously included in taxable income, for example as invoiced revenue. Allowances against receivables from related parties or against claims that did not arise from ordinary trading are not deductible and are added back when computing the tax.

How it works in practice

In practice the accountant reviews the receivables ledger at year end and, based on how long each item is overdue, calculates the deductible and non-deductible parts of the allowance. The deductible part reduces the tax base, the rest is added back in the return, and when the debt is later paid or written off the allowance is released.

If the receivable becomes definitively uncollectable, for example after bankruptcy proceedings end, a write-off follows. The write-off is deductible up to the allowance already recognised for tax, or in full where it is an irrecoverable receivable as defined by law.

It pays to send reminders promptly and document collection steps. Reminders, a claim filed in bankruptcy or a court ruling help show in a tax audit that the allowance was justified and correctly calculated.

What to watch out for

An allowance is not deductible just because a debt is old. If the receivable was offset, assigned or partly paid, both its amount and the overdue period change. Mistakes show up in an audit as an understated tax base, with interest and penalties.

For VAT payers, an unpaid receivable also opens the possibility of correcting the VAT base once it is uncollectable. This is a separate procedure with its own conditions, not directly tied to the allowance, and the debtor must at the same time adjust the input VAT it deducted.