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HMRC internal manual

VAT Bad Debt Relief

Payments: Example of attribution for goods supplied with finance under hire purchase, conditional sale or credit sale agreements: Introduction

Regulation 170A sets out particular attribution rules for goods supplied with a supply of credit under hire purchase, conditional sale or credit sale agreements. Where a business supplies goods on credit it makes two supplies – goods (taxable) and credit (exempt). The supplier must account for VAT on the supply of goods at the outset following the normal time of supply rules. However, sometimes agreements are terminated because customers default on the agreements.

If a customer makes some of the periodic payments before defaulting, these payments will cover both the goods and interest. In order to work out the amount of bad debt relief claimable on the goods, the supplier will need to look back at the payments the customer made before defaulting and allocate them between the goods and the interest. Payments upon which interest is not charged are not attributed in this way: for example the interest charge will be calculated after deducting the amount of the deposit. The supplier will then be able to determine how much remains unpaid for the goods and so how much of the output tax previously paid can be reclaimed as bad debt relief.

The old method used a ‘straight-line’ methodology, and an example of the calculation can be found in VBDR2420.

An amendment has been made to Regulation 170A, which took effect from 1 March 2007. This change affects how the supplier calculates bad debt relief. The new method reflects existing commercial practice and allows bad debt relief to be calculated on the actual value of capital outstanding under the terms of the agreement, based on the payments made by the customer. Where the customer pays late, misses payments or the agreement allows for instalments to be attributed to increased interest costs first, there may be an impact on the attribution between interest and capital. This new method will give a more accurate figure for the amount outstanding for the goods and should result in a higher amount of bad debt relief than using the old method.

For supplies of goods made before 1 September 2006 the old method of calculation (at paragraph 5 of regulation 170A) must be used.

For supplies of goods made between 1 September 2006 and 31 August 2007 suppliers may choose either method. Suppliers may choose to calculate their bad debt relief claims using the old method initially and then re-compute the claim using the new method. Suppliers can then adjust the difference, subject to the normal rules.

For supplies of goods made on or after 1 September 2007 the new method of calculation (at paragraph 6 of regulation 170A) must be used.

Businesses will not have to notify their customers which method they have used, as defaulting customers will continue to use the old method to calculate the amount of VAT to be repaid toHMRC.