Late payment is a worry for any business. Here are a few practical pointers.
Business Contracts
First, written terms of business with your customers are essential.
Here are some things you may want to look for in an agreement:
- Employment status – if you are working though a Personal Service Company state this. If you are a Sole Trader state Self Employed
- The tasks to be done
- Place and time the tasks are to be carried out
- Payment rate
- Payment and invoicing terms
- Any special arrangements or requirements
At the simplest level this is common sense. Alternatively you may operate with a more wider range supply agreement or set of terms of business. Get help from a solicitor to make sure they are robust and enforceable.
As a minimum include a clause on your invoices with your payment terms and the wording “Interest and Late Payment Charges will be applied under Late Payment of Commercial Debts (Interest) Act 1988 as amended by EC Directive 2000/35/EC”
In many cases contracts are imposed on business, eg
- Freelancers/contractors working through agencies / direct contracts
- Small businesses dealing with larger ones or public entities
If this is the case payment terms should be covered in there – be aware that courts may strike down terms if they are manifestly unfair and not freely negotiated.
What if that your suppliers imposed terms says something different to your invoice? Well normally, a contract imposed by a larger customer will have a clause saying their contract is the extent of the agreement between the businesses. That is normally definitive, although the “rough justice” approach of the Small Claims Court may over turn that if it was unfair and/or bargaining power was unequal. As well as payment arrangements, interest arrangements in the event of late payment may also be stated.
If you are responsible for setting contract terms then, amongst other things, make sure payment time-scales and late payment provision are clearly set out and agreed.
Late Payment Rules
Suppose the terms are not clearly agreed one way or another? Or payment is outside of terms?
Well, here legislation helps, specifically Late Payment of Commercial Debts (Interest) Act 1988 as amended by EC Directive 2000/35/EC. See the simple guide to this by HM Government.
These are set under Late Payment of Commercial Debts (Interest) Act 1988 as amended by EC Directive 2000/35/EC, and apply in the absence of any other contractual agreement.
These rules stipulate the following where there is no agreement to the contrary:
- A payment is late after 30 days
- Late payment (after thirty days or whatever else is agreed) is subject to interest at 8% over base (simple daily rate not compound)
- Credit charges can be added to the debt at prescribed rates:
- Debts of up to £999.99 – £40
- Debts £1,000 to £9,999.99 – £70
- Debts over £10,000 – £100
These are useful provisions as only court costs, and not legal fees, can be recovered in a Small Claims Court action.
What To Do If You Are Not Paid
Depending on the size of the debt, and the situation your customer is in, you may want to engage the services of a solicitor who specialises in debt recovery.
You could take this on yourself – a Small Claims Court action is relatively easy to start but there are pitfalls, and even if your claim is successful in the Court, recovery of the debt under a judgement is still left for you to deal with, so a court judgement does not guarantee payment. See Money Claim Online, HM Court Services Official Online Service – but you do need to be spot on with your paperwork as there tends to be a “rough justice” approach.
If you intend to pursue the outstanding debt through legal proceedings, it is probably going to be worthwhile engaging a professional to do this for you – however the costs of this cannot be recovered in the event of a win (court costs can, not legal fees).
Keep a record of correspondence relating to the unpaid debt – statements, reminders, solicitor’s letters etc. These will need to be produced if HMRC wishes to review the circumstances of your bad debt claim in the event that your efforts to recover payment are unsuccessful.
Before you embark on any costly legal proceedings, try to ascertain the current trading position of the defaulting customer, are they subject to insolvency/bankruptcy proceedings for example? If so, it will probably be pointless pursuing any unpaid debts, as the company’s assets will be frozen. In due course, you should be contacted by the Insolvency Practitioner handling the case, once they have determined who the creditors are. In most cases there will be insufficient funds to pay out to anyone except the preferred creditors (Banks, HMRC, unpaid staff wages), so the chances are you will be a long way down in the pecking order. However, written confirmation from the insolvency firm is sufficient for bad debt write off purposes.
What if the Unrecoverable Debt Puts Your Own Business in Financial Trouble?
This can be a real headache for an owner managed business. Even though you have uncollected debts, there are still the usual day to day bills to pay, including taxes. During the period when you have been building up a sizeable total of unpaid sales invoices, you may have been forced to use company tax savings to fund your own drawings, salary and dividend, with the intention of plugging the hole once the payments came in. The result: insufficient funds to pay the company’s tax and vat debts.
The first rule is don’t bury your head in the sand, and don’t put action off until it becomes an even bigger problem.
If you cannot see an appropriate way out of the company’s financial situation, and wish to get your company back to a solvent position, it may be useful to speak to an Insolvency Practitioner. Don’t be alarmed by the title, they are not simply in the business of winding companies up, they also have a role in assisting businesses to find a way back from the brink. Insolvency Practitioners can advise and assist you in discussions with HMRC over unpaid taxes, and offer ideas to help you get your company back on its feet.
Bad Debt Relief for Tax Purposes
Under current HMRC rules for Business Profits, a deduction for a bad or doubtful debt can be made against the profits in the year in which the debt becomes bad or doubtful. Efforts to recover the debt must have been made, and should be evidenced.
Once the bad or doubtful debt has been established, a deduction, by way of a write off, can be made in the company accounts. This should be done in the period in which the decision to write off is taken. Any subsequent debt recovery must be included in the accounting period in which it is received. The bad debt is shown as an expense in the profit and loss account, but the original sale value will also be included in sales income, in the year in which the services were supplied. HMRC may wish to enquire into the circumstances of a bad debt write off, especially if it is sizeable, so it is better to be forearmed.
Bad Debt Relief for VAT Purposes
If you sell something to a customer but the customer never pays you, you can reclaim the VAT you charged and paid to HMRC. HMRC calls this ‘bad debt relief’.
The recovery rules vary according to which VAT scheme you use:
- If you are using the VAT “cash accounting” scheme and are applying normal vat (not flat rate) there should be no VAT bad debt relief to consider, as you wont actually have paid the VAT
- If you are using the invoice basis of VAT accounting you can adjust your vat return to secure a refund. To do this:
- The debt must be more than six months old and, and less then four years and six months old
- You add the amount of VAT you are reclaiming to the amount of VAT you are reclaiming on your purchases (input tax) and put the total figure in Box 4 of your VAT Return.
- To work out how much bad debt relief you can claim on a VAT inclusive balance, you need to apply the appropriate VAT fraction to the unpaid amount.
- Businesses using the Flat Rate Scheme for VAT are subject to special rules are eligible for bad debt relief if:
- you have not been paid by your customer and it has been at least six months since you made the supplies
- you have not accounted for and paid tax on the supply
- you have written off the debt in your accounts
- If you meet all these conditions, your claim will be for the full amount of the VAT you charged your customer (not the Flat Rate amount) and should be included in box 4 of the next VAT return.
HMRC Guidance – Normal VAT and Cash Accounting and Flat Rate users