Writing off bad debts: income tax and GST/HST

A customer stops answering. The invoice ages past ninety days, then a year. Eventually the receivable is a bookkeeping fiction, and two separate reliefs apply, on two returns, with separate conditions. Owners often claim one and forget the other.

Part one: the income tax deduction

Subparagraph 20(1)(p)(i) of the Income Tax Act authorizes a deduction for a bad debt where three requirements are met:

1. the debt was owing to you at the end of the tax year;
2. the debt became bad during that tax year; and
3. the amount was included, or deemed to have been included, in your income for that year or a previous year.

The third condition is the one that surprises people. If the revenue was never recorded in income, there is nothing to deduct. You have simply not been paid for work you never booked as a sale. Writing it off changes nothing.

When does a debt become “bad”?

The Act sets no specific conditions. The CRA’s position is that the decision should follow determined but unsuccessful collection efforts, or clear evidence the amount is uncollectible. Customer bankruptcy, a business that no longer exists, a statute-barred claim, or an exhausted collection file all point that way.

Crucially, a debt that is merely doubtful should not be claimed as a bad debt. Doubtful accounts use a reserve under paragraph 20(1)(l), deducted one year, added back the next and reassessed. The two are reported differently, so the distinction matters.

Partial write-offs and later recoveries

If part of a debt is collectible, only the uncollectible portion is a bad debt. If the customer later pays, the recovery goes back into income — the deduction is reversed. Keep the write-off memo, which supports both halves.

Part two: getting the GST/HST back

If you invoiced GST or HST on that sale, you almost certainly remitted it long before the customer defaulted. The tax you sent to the CRA came out of your own pocket. The bad debt adjustment gets it back.

The conditions in CRA Guide RC4022 are specific:

• You already reported and remitted the GST/HST on the credit sale.
• All or part of the amount owed became a bad debt.
• You deal at arm’s length with the customer.
• You write the amount off as a bad debt in your records.

You then claim the tax adjustment on line 107 of the GST/HST return if you are filing electronically through NETFILE or on paper, or within your line 108 calculation if you file using TELEFILE.

The formula

The adjustment is not simply the tax on the invoice. It is prorated to the unpaid portion, using the tax rate that applied at the time of the sale:

Because B and C both include provincial sales tax where it applied, a BC business writing off an invoice that carried BC PST has to run the formula on the tax-included figures, not the net sale.

Deadlines and recoveries

The adjustment has to be made on a return filed within four years of the due date of the return for the reporting period in which you wrote off the bad debt. That is generous, but it starts running from the write-off, so a receivable written off and then forgotten can time out.

If you later recover money, the GST/HST portion goes back to the CRA. Report it on line 104 if you file electronically or on paper, or as an adjustment in your line 105 calculation using TELEFILE, for the period of recovery, with the same proportional formula.

Both parts are easier when the write-off ends a documented process rather than a year-end decision. The guide to receivables and collections covers the terms, follow-up and aging review that produce that evidence.

What to keep on file

A bad debt write-off is a deduction you claimed against yourself, so the evidence has to be yours. Keep the original invoice, the aged receivable listing showing the balance, the record of collection attempts — statements, emails, a collection agency file, a bankruptcy notice, and a dated memo recording the decision to write the amount off and the reasoning. All of that falls under the ordinary record retention rules.

Then make sure the two claims line up. The income tax deduction goes on the corporate return for the year the debt went bad; the GST/HST adjustment goes on the return for the period you wrote it off. They are different filings and they are checked separately, a reviewer looking at your input tax credits and adjustments will not see your T2, and vice versa. If you would rather not track two clocks, we handle the GST/HST filing and the corporate return together.

Where the unpaid invoice was denominated in a foreign currency, a second adjustment arises alongside the write-off — see how foreign exchange gains and losses are taxed.

This article is general information, not tax advice for your specific situation. Tax rules and CRA administrative positions change — confirm anything that affects a decision with the CRA or with us first.