Unpaid invoices are a headache no business wants — not only do they affect cash flow, but they can also complicate your VAT returns. When a customer fails to pay, you might wonder: Should I issue a credit note or claim VAT Bad Debt Relief (BDR)?
While both options can offer VAT relief, they’re not interchangeable — and using the wrong one could land you in hot water with HMRC.
Here’s a breakdown of when to issue a credit note and when to claim VAT bad debt relief.
📄 When Should You Issue a Credit Note?
A credit note is appropriate only in the following situations:
- The original invoice was incorrect (e.g. wrong price, quantity, or tax rate)
- Goods were returned by the customer
- A discount or reduction in price was agreed after invoicing
In these cases, issuing a credit note:
✅ Reduces the customer’s liability
✅ Adjusts your output VAT
✅ Allows the customer to reduce their input VAT (if they are VAT-registered)
⚠️ Important: You cannot use a credit note as a shortcut to recover VAT on unpaid invoices. It only has legal standing when it’s been sent to the customer — and it must reflect a genuine adjustment to the original transaction.
🛑 When Should You Use VAT Bad Debt Relief (BDR)?
BDR is available when:
- The invoice has gone unpaid
- The goods/services have been supplied
- You’ve already paid the VAT to HMRC
You can claim VAT bad debt relief on your VAT return — but only if all of the following conditions are met:
✅ Conditions for a BDR Claim:
- The VAT has been accounted for and paid to HMRC.
- The debt is more than 6 months old, calculated from:
- The invoice date, or
- The payment due date, if stated.
- The invoice date, or
- The debt has been written off in your accounts and transferred to a separate bad debt account.
- The value of the invoice must not exceed the normal selling price.
- The debt hasn’t been sold, factored or assigned to another party.
If the customer later pays the invoice, you must repay the VAT to HMRC on your next return.
🤔 What About Price Reductions? Use Regulation 38
There’s one other scenario where you can reduce VAT — if the price genuinely changes after the VAT was accounted for.
This falls under Regulation 38 VAT adjustment, which allows for changes in VAT following a post-invoice price reduction (not due to non-payment).
To qualify:
- There must be a genuine price reduction
- A refund is made to the customer
- A credit note is issued (must be issued within 14 days of the price reduction)
- Both supplier and customer adjust their VAT accordingly
There’s no time limit on using Regulation 38 — even a 5-year-old invoice can be adjusted if it qualifies. But be aware: if you’re past the 6-month limit, you cannot claim BDR on that same invoice.
💡 Practical Tip
Before doing anything, ask:
- Was the invoice incorrect? Issue a credit note.
- Was the customer unable or unwilling to pay? Consider BDR after 6 months.
- Was there a commercial agreement to reduce the price? Use Regulation 38.
Be sure to keep detailed records, including correspondence, account entries, and VAT return adjustments. HMRC will expect to see clear audit trails if they ever review your records.
📌 Summary Table
| Scenario | Credit Note | Bad Debt Relief |
| Invoice error | ✅ Yes | ❌ No |
| Goods returned | ✅ Yes | ❌ No |
| Post-invoice discount | ✅ Yes (Reg 38) | ❌ No |
| Customer won’t pay | ❌ No | ✅ Yes (after 6 months) |
| Legal recovery ongoing | ❌ No | ❌ Wait until outcome |
🧾 Final Thought
It’s tempting to use credit notes to quickly deal with unpaid invoices — but doing so inappropriately could cause VAT errors and compliance risks. BDR is the correct route when a customer simply hasn’t paid. Credit notes should only reflect changes to the original sale.
Knowing the difference — and applying the right process — could save your business time, stress, and money.
Partner note:
https://www.gov.uk/guidance/relief-from-vat-on-bad-debts-notice-70018
Revenue and Customs Brief 6: Changes in accounting for VAT after prices are altered
VAT Act 1994, s 36 and s 26A
VAT Regulation 38
