The Australian Taxation Office (ATO) has issued a ruling that clarifies the circumstances in which a deduction for bad debts is allowable.

Under section 63 of the Act, to obtain a bad debt deduction a debt must exist before it can be written off as bad. A debt exists where a taxpayer is entitled to receive a sum of money from another, either at law or in equity i.e. a customer becomes bankrupt after you have already provided services to them.

The question of whether a debt is ‘bad’ is a matter of judgment having regard to all the relevant facts. Generally, provided a bona fide commercial decision is taken by a taxpayer as to the likelihood of non-recovery of a debt, it will be accepted that the debt is bad for section 63 purposes. The debt, however, must not be merely doubtful.

A bad debt has to be written off in the year of income before a bad debt deduction is allowable under section 63. The writing-off of a bad debt does not necessarily require highly technical accounting entries. It is sufficient that some form of written record is kept to evidence the decision of the taxpayer to write off the debt from the accounts.

The debt must have be brought to account as assessable income in any year or, in the case of  a money lender, the debt must be in respect of money lent in the ordinary course of the business of lending of money by a taxpayer who carries on that business.

Individuals may be able to claim a bad debt as a tax deduction if the amount owed has been included in an individual’s assessable income in the year of income in which the debt is written off.

For those who pay GST on an accruals basis, you may also be able to claim back a GST credit. If you have paid GST on a sale but did not end up receiving any payment for that sale then you are able to adjust your BAS accordingly. You can make the adjustment to your BAS in the period when the debt was written off, or twelve months after the debt became due (whichever is relevant to your situation).

Individuals are also entitled to claim a tax deduction for a partial bad debt that has been written off on that portion of the debt. The same concept applies for GST adjustments.