If you’re owed money and it seems unlikely you’ll ever get paid, you might be able to write off the debt to reduce your taxable income or claim back GST you’ve paid if you are on the invoice basis for GST. 

Here’s a simple guide to how it works.

What qualifies as a bad debt?

• You must already be owed the debt. 

• You must have taken all reasonable steps recover the debt. 

• A reasonable person (like a business professional) must decide that there’s no real chance the debt will be paid, either fully or partially. 

• You must have recorded the bad debt correctly as outlined below. 

How to write off the debt?

• You need to document the debt as written off during the tax year or GST period you want to claim the deduction for. 

• How you record this depends on how you keep your books. Most people these days are using accounting software such as Xero, and if you are, then an authorised person must enter it into the system, marking the debt as written off.  

How to write off a bad debt in Xero

So that’s it? 

In most cases the important considerations are whether the debt is bad, and whether it is written off. Most business owners will try as hard as possible to recover a bad debt, the important step that can sometimes be left out is to actually write that debt off in your accounting software. It’s important to note that you can’t get a deduction if you think the debt is doubtful or just unlikely to be paid, there must be no real chance of repayment. To be clear, the deduction is available on the date that the debt is written off i.e. you cannot backdate that process to get the deduction in a prior financial year. 

By properly handling bad debts, you can claim income tax deductions or GST refunds*, helping to reduce your overall tax burden. Always make sure your records are clear and up to date to avoid issues with the IRD. 

*Note that if you’re using the cash basis for GST, a bad debt won’t affect GST, because the GST is only reported once the payment has been received from the customer.