How to Handle Bad Debts and Write-Offs Properly under ATO Rules

Bad debts are unpaid invoices that can be claimed as deductions if written off correctly. Cotchy explains ATO rules, BAS adjustments, and prevention strategies.

In business, not every customer pays on time, or at all. For small and medium businesses in Australia, unpaid invoices (bad debts) are a frustrating reality. They can affect cash flow, profitability, and even the ability to pay suppliers or staff.

The good news is that under ATO rules, businesses can sometimes claim a tax deduction for bad debts that are written off correctly. However, the rules are strict. Get it wrong, and you risk losing the deduction or triggering an audit.

At Cotchy, we help businesses across Australia manage this process, from recognising genuine bad debts to writing them off in a way that meets compliance requirements.

This guide explains:

• What the ATO considers a “bad debt.”
• The steps to correctly write off a debt.
• The impact on your tax and BAS.
• Practical strategies to reduce future bad debts.

What Is a Bad Debt?

The ATO defines a bad debt as one that is:

• Genuinely unrecoverable: Despite reasonable efforts, the customer will not pay.
• Written off in the accounts: You must formally record it as a bad debt.

Example: If a customer disputes an invoice but you haven’t attempted recovery, it’s not yet a bad debt. But if the customer has gone into liquidation and recovery is impossible, the ATO may accept it as a bad debt.

Conditions to Claim a Tax Deduction

To deduct a bad debt, you must meet three conditions:

1. Incurred income – The amount must have previously been included in your assessable income (eg, sales or service invoices).
2. Written off – The debt must be written off in your accounts before the end of the financial year.
3. Irrecoverable – You must show reasonable attempts to recover the debt (letters, calls, debt collectors).

If these steps aren’t followed, the ATO may disallow the deduction.

How to Write Off a Bad Debt – Step by Step

1. Review the debt – Confirm that the invoice was issued, recorded as income, and is still unpaid.
2. Attempt recovery – Send reminder notices, make phone calls, or engage a debt collector.
3. Assess irrecoverability – If recovery is unlikely (eg, client insolvency), prepare to write it off.
4. Board/manager approval – For companies, have the directors approve the write-off.
5. Journal entry – Record the write-off in your accounts by:
   • Debiting Bad Debt Expense.
   • Crediting Accounts Receivable.
6. Retain documentation – Keep all correspondence and approval notes as evidence.

Example journal entry in Xero:
Bad Debts Expense (Debit) $2,000
Accounts Receivable (Credit) $2,000

GST and BAS Implications

If you have already paid GST on a sale, writing off a bad debt may allow you to claim a decreasing adjustment on your next BAS.

• If you account for GST on an accrual basis (non-cash basis): You can claim back the GST portion when either:
  • You write the debt off as bad, OR
  • The debt has been overdue for 12 months or more
• If you account for GST on a cash basis: You won’t need an adjustment because GST is only paid when cash is received.

The decreasing adjustment is calculated as 1/11th of the amount written off or overdue.

Common Mistakes Businesses Make

• Writing off debts too early, before exhausting recovery efforts.
• Forgetting to adjust GST in BAS.
• Not documenting approvals for write-offs.
• Treating disputes or late payments as bad debts prematurely.

Strategies to Reduce Bad Debts

While you can claim deductions, prevention is better than cure. Consider:

• Upfront deposits: Reduce exposure by securing part payment before starting work.
• Credit checks: Review new clients before extending terms.
• Clear contracts: Set payment terms and late fee policies in writing.
• Automation: Use Xero or MYOB reminders to chase invoices promptly.
• Debt collection services: Engage professionals early for overdue accounts.

How to Handle Bad Debts and Write-Offs under ATO Rules – Cotchy Can Help

Bad debts can’t always be avoided, but handling them correctly means you won’t miss out on valuable tax deductions.

At Cotchy, we:

• Review and document debts for compliance.
• Prepare journal entries and BAS adjustments.
• Help set up systems to reduce overdue accounts.
• Provide strategic advice to strengthen cash flow.

Don’t let unpaid invoices cost your business more than they should. Ensure your bad debts are managed properly and in line with ATO rules. Chat with our team at Cotchy to learn more.

FAQs: Bad Debts

Q1. Can I claim a tax deduction for unpaid invoices? Yes, if the debt was included in income, is irrecoverable, and written off in your accounts.

Q2. Do I get GST back on bad debts? If you report GST on an accrual basis, you can claim a decreasing adjustment when the debt is written off or has been overdue for 12 months or more.

Q3. What’s the deadline for writing off bad debts? They must be written off in your accounts before 30 June of the relevant financial year.

ATO Sources:– Deductions for unrecoverable income (bad debts), Taxation Ruling TR 92/18 – Income tax: bad debts, GSTR 2000/2 – Goods and services tax: adjustments for bad debts, Types of adjustments (GST)