Writing Off Unpaid Invoices in Canada: Bad Debt and GST/HST

Can I write off an unpaid customer invoice as a loss in Canada?

Yes, for income tax, if the invoice was already counted in your income and has become uncollectible. The price before tax is then a bad debt expense, and the GST/HST on it may be recovered separately on line 107 of your GST/HST return, if the conditions below are met. A debt that is only doubtful is treated differently:

The income tax rules are in paragraphs 20(1)(l) and 20(1)(p) of the Income Tax Act. The GST/HST rule is in section 231 of the Excise Tax Act. Both are federal rules and apply in every province. A partnership works out its income as if it were a separate person (s. 96), so it deducts the bad debt when it calculates partnership income; each partner then reports a share of that net income, at amount 5A of Form T2125 or from the T5013 slip, and does not deduct the debt again. A sole proprietor enters the bad debt on line 8590, Bad debts, of Form T2125; a corporation uses GIFI 8590 on its T2 (see the books section below).

A case is not simple when the sale falls in a year already filed, the client is related to you or outside Canada, the sale or the write-off is several years old, the GST/HST on the sale was never reported or paid, or a corporation holds many receivables at year end. Gather the invoice and the return that reported it, a list of what customers owe by age, proof of your collection efforts, the date each debt was written off in your books, and the GST/HST returns for the sale period and the write-off period.

When is an unpaid invoice a bad debt and not just a doubtful one?

A debt is bad when it is established as uncollectible, not when it is merely late. The Income Tax Act deducts debts you establish have become bad in the year, and the Excise Tax Act asks that it be established that all or part of the debt has become bad (s. 231(1)). Neither Act sets a number of days overdue.

CRA's bulletin IT-442R says a debt that is merely doubtful should not be claimed as bad, and looks for unsuccessful, determined collection efforts or clear evidence that the debt cannot be collected. The bulletin is archived and no longer updated, so treat it as historical guidance. Because the test is a question of fact, keep the evidence:

• Dated reminders, calls and emails demanding payment.
• A bankruptcy, insolvency or closure of the client's business.
• A collection agency or lawyer report that nothing can be recovered.
• The write-off entry itself.

The income tax deduction is for the year the debt became bad. A deduction for a debt that became bad in an earlier year cannot be deferred and claimed in a later one (IT-442R). Whether an earlier filed return can still be changed is a question for a professional.

If you and the customer agree to cut or cancel the price, that is a price reduction, not a bad debt, and the GST/HST side follows the credit-note rule; see GST/HST on deposits and unpaid invoices. Accepting less because the rest cannot be collected may still be a bad debt, so settle which one happened before you adjust the tax. A dispute alone is neither. Do not delete an invoice you are still owed.

Why does the invoice have to be in income before I can write it off?

A bad debt deduction cancels income you already reported, so the invoice must have been included in income first (T2125 line 8590; paragraph 20(1)(p)). CRA requires the accrual method for most self-employment income, which counts income when earned, paid or not.

CRA allows the cash method only for farmers, fishers and self-employed commission agents; all other self-employment income must use the accrual method (CRA). An accrual-method invoice is already in income, so it can be written off once the debt is bad. On the cash method, an unpaid invoice was never in income, so there is nothing to deduct. Work you never invoiced and never counted in income has nothing to deduct either. The GST/HST rule does not ask how you report income. If you reported on the cash basis in past years but the accrual method applied, your earlier returns may need correcting before any write-off. See cash or accrual accounting for who may use which method.

Can I set up an allowance for doubtful accounts for tax?

Yes, as a reserve, for debts already counted in income and only for a reasonable amount. Paragraph 20(1)(l) allows a reasonable amount for doubtful debts that were already included in income. The reserve lasts one year: the amount deducted is added back to income the next year (paragraph 12(1)(d)), and you set a new reserve from the facts at that year end. A reserve brings part of a possible loss into this year's deduction and reverses next year. It does not write the debt off.

"Reasonable" means tied to the accounts you actually doubt. IT-442R says a reserve built on a percentage of all debts or of gross sales is not reasonable, and that it should rest on identified doubtful debts. Keep a list of each account, the amount reserved and why.

Where the reserve goes depends on who files:

• Sole proprietor: last year's reserve is added to income on line 8290, Reserves deducted last year (CRA). CRA lists allowable reserves among other business expenses. Other T2125 lines are in expense lines for the self-employed.
• Corporation: Schedule 13 shows the continuity of reserves, with the opening balance added on Schedule 1 line 125 and the closing balance deducted on line 413 (T4012). An allowance booked in the financial statements is not automatically the tax reserve: reserves from the statements are adjusted separately on Schedule 1; see why taxable income differs from book profit.

A reserve gives no GST/HST relief. Section 231 deducts tax only on a debt established as bad and written off.

How do I get the GST/HST back on a written-off invoice (line 107)?

Deduct it on line 107 of the GST/HST return for the reporting period that includes the write-off, or a later one (s. 231(1)). Do not amend the return that first reported the sale (CRA return instructions).

The deduction is A × B ÷ C:

• A is the GST/HST on the sale.
• B is the unpaid price, tax and applicable provincial tax that you wrote off.
• C is the total price, tax and applicable provincial tax on the sale.

Writing off the whole invoice recovers the whole tax, if the conditions below are met. A partial write-off recovers the same share. In an HST province, the HST is the tax. Where a prescribed provincial sales tax was charged on the same sale, it counts in B and C, but only the GST/HST comes back (s. 231(5)). To file the return itself, see filing GST/HST and input tax credits. Whether GST/HST was owed on the unpaid invoice in the first place is covered in GST/HST on deposits and unpaid invoices.

What conditions apply to the GST/HST claim?

Every condition in section 231 must be met:

1. Taxable, not zero-rated. A zero-rated sale carries no tax to recover.
2. Client not related to you. Related persons are treated as not dealing at arm's length, and for unrelated persons it is a question of fact (s. 126). Related means related under the Income Tax Act (s. 251): for example, family connected by blood, marriage, common-law partnership or adoption, and a corporation and the person who controls it. A member of a partnership is also treated as related to the partnership, so an amount a partner owes the partnership does not qualify.
3. Bad and written off in your books. It must be established that all or part of the debt is bad, and you must write it off in your books of account.
4. Tax reported and paid. You reported the GST/HST on the sale on your return for the period it became collectible, and you paid whatever that return showed you owed (s. 231(1.1)).
5. In time. The claim must be on a return filed within the limit below.

A balance still owing on that return blocks the claim. So does tax that was never reported. A related client blocks it too, even though the debt may still be bad for income tax.

How long do I have to claim the GST/HST?

The return that claims it must be filed within 4 years after the day the return for the write-off period was due (s. 231(4)). The clock starts with the period in which you wrote the debt off in your books, not the period of the sale.

A write-off entry made years ago and never claimed may already be out of time. The Act ties the GST/HST clock to the books and the income tax deduction to the year the debt became bad. When those differ, confirm both dates before claiming either.

What if the client pays part of it later?

A payment on a debt you deducted as bad in an earlier year is income again, and part of the GST/HST you deducted on line 107 is added back. The sale-price part of the payment is income in the year received (paragraph 12(1)(i)); a sole proprietor enters it on line 8230, Other income (CRA).

The tax share goes on line 104 of the return for the period you receive the money, but only if you claimed the line 107 deduction (s. 231(3)). It is A × B ÷ C, where A is the amount recovered, B is the GST/HST on the sale, and C is the total price, tax and applicable provincial tax.

What changes in Quebec, and what about PST in BC, Saskatchewan and Manitoba?

In Quebec, the GST part follows the same section 231, but Revenu Québec generally administers the GST/HST there, so the claim goes on the return filed with it (RC4022). This page does not cover the QST bad debt adjustment; start with Revenu Québec's bad debts page.

PST in British Columbia, Saskatchewan and Manitoba is a separate provincial tax. Section 231 returns only the GST/HST, and this page does not state any province's PST relief. Start with provincial sales tax.

How do I record the write-off and the GST/HST in my books?

Date the write-off entry accurately: its period decides which GST/HST return carries the claim and starts the time limit. Use the same accounts the return reads from; see recording GST/HST in your books.

The GST/HST entries below assume the write-off qualifies for line 107, and the recovery entry assumes line 107 was claimed. If relief is unavailable, for example for a related client or a Quick Method sale, settle how the unrecovered tax is treated before posting them.

On a corporation's T2, the GIFI code for bad debt expense is 8590 and for the allowance for doubtful accounts is 1061 (CRA GIFI guide).

Does the Quick Method change the claim?

Yes, for the GST/HST. A business using the Quick Method generally cannot adjust its net tax for bad debts on sales included in the Quick Method calculation. Line 107 is for bad debts on supplies outside that calculation, and line 104 for their recovery (CRA Guide RC4058). The income tax rules above still require the sale to have been in income. How the Quick Method shapes that income is in the Quick Method in your books.

Example

These examples are illustrative; the figures are in Canadian dollars.

A consultant's client becomes insolvent

An Ontario consultant bills C$10,000 plus C$1,300 HST, C$11,300 in all, in March. She uses the regular GST/HST method and deals at arm's length with the client. She reports and remits the HST for that period. The client becomes insolvent, she has documents showing nothing can be recovered, and she writes off C$11,300 in December.

For income tax, C$10,000 can then be a bad debt, because it was already in her income. For HST, A is 1,300, B is 11,300 and C is 11,300, so the deduction is C$1,300. She takes it on line 107 of the return for the period that includes the December write-off, not the March return, and files within the time limit above.

A corporation with receivables at year end

A corporation has C$60,000 of receivables at year end, excluding GST/HST and already included in income, C$8,000 of it from two named customers long overdue. It judges that C$5,000 of that is unlikely to be collected and reserves C$5,000, tied to those two accounts rather than a percentage of sales.

The reserve is deducted this year and added back to income next year, when a new reserve is set from that year end's facts. No GST/HST is recovered yet. If one of the two customers later fails and the debt is written off as bad, the bad debt deduction follows in the year it becomes bad, and the line 107 claim in the GST/HST period that includes the write-off, if the conditions above are met.

A partial payment after a write-off

A client pays C$2,000 on the C$11,300 Ontario invoice above, which was written off last year. The tax share is 2,000 × 1,300 ÷ 11,300, or about C$230.09, added on line 104 for the period the money arrives. The other C$1,769.91 is income again.

Different for you?

• A large invoice whose HST you remitted years ago: the 4 years window may be closing or closed, and the right year for the income tax deduction may differ. Get the dates and the claim checked with bookkeeping help.
• The client is related to you (a company you or your family control, or a partner), or is outside Canada: a related client blocks the GST/HST deduction. A sale to a client abroad may have been zero-rated, which leaves no tax to recover; whether yours was depends on what you sold. See charging GST/HST to US customers, and settle which rule applies with bookkeeping help.
• You are a corporation with receivables at year end: deciding which accounts are bad and which are only doubtful, and carrying a reserve through Schedule 13, is year-end work. See the year-end close checklist and get bookkeeping help.
• GST/HST returns are unfiled, or tax on the sale was never paid: the claim depends on the original tax being reported and remitted. See unfiled GST/HST returns, and get bookkeeping help to rebuild the records.
• Your books are behind: see catching up on overdue books before deciding what to write off.
• The money came as a deposit or prepayment: see customer prepayments and unearned revenue.
• You are in Quebec or a PST province: QST and PST rules differ. Start with provincial sales tax.