Writing off bad debts: income tax and GST/HST

A customer stops answering. The invoice ages past ninety days, then past a year. At some point the receivable stops being an asset and starts being a bookkeeping fiction — and at that point there are two separate reliefs available, on two separate returns, with two separate sets of 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 authorises 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”?

There are no specific conditions set out in the Act. The CRA’s stated position is that the decision should be made only after determined efforts to collect the debt have been unsuccessful, or where there is clear evidence that the amount has in fact become uncollectible. Bankruptcy of the customer, a business that has ceased to exist, a claim that is statute-barred, or a documented collection file that has run out of options all point the same way.

Crucially, a debt that is merely doubtful of collection should not be claimed as a bad debt. Doubtful accounts have their own mechanism: a reserve under paragraph 20(1)(l), which is deducted in one year and added back to income in the next, then re-assessed. That distinction is worth getting right, because the two are reported differently.

Partial write-offs and later recoveries

Where part of a debt is collectible and part is not, only the uncollectible portion is treated as a bad debt. And if the customer later pays after all, the recovered amount is brought back into income — the deduction is reversed, not permanently kept. Keep the write-off memo, because it is what supports both halves of that story.

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 collect some of the money, the GST/HST portion of what you recover goes back to the CRA. You 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 in which the amount is recovered — using the same proportional formula applied to the amount recovered.

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.

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.