VAT disallowed on liquidated debtor

[bammer]

The credit notes were issued against a "bad debt" debtor, did not reduce vat on the supply of goods, and was claimed for under "Adjustments - Bad debts".

If I understand your comment correctly, credit notes should not have been issued at all, but adjustments made via journal entry?

That is correct.

Note the following extracts from the attached VAT 404 - Guide for Vendors, which provides more detail in this regard (footnotes omitted):

CHAPTER 14

DEBIT & CREDIT NOTES

14.1 INTRODUCTION
A debit note will normally be issued by the supplier when the tax invoice for the supply has already been issued and the previously agreed consideration is subsequently increased. Conversely, a credit note will normally be issued by the supplier when the tax invoice for the supply has already been issued and the previously agreed consideration is subsequently reduced. A credit note is also issued by the original supplier when faulty goods are returned by the customer. Debit and credit notes therefore provide a mechanism to support the necessary VAT adjustments required or allowed where an event has the effect of altering the original consideration agreed upon for a past taxable supply, after the tax invoice has already been issued, or the vendor has accounted for the supply on a VAT return.

14.2 WHEN MUST DEBIT AND CREDIT NOTES BE ISSUED?
The following are the circumstances under which it will be necessary to issue a debit note or credit note:

• A supply of goods or services is cancelled.
• The nature of the supply of goods or services has been fundamentally varied or altered.
• The previously agreed consideration for the supply of the goods or services is being altered by agreement with the recipient (including a discount).
• Part of, or all the goods or services supplied are returned to the supplier (including any returnable container returned to the supplier).
• The price on the tax invoice was either overstated or understated.

This will, however, only be necessary if in respect of any of the above circumstances the supplier has either –

• issued a tax invoice and the tax charged is incorrect; or
• furnished a VAT return in which the incorrect amount of output tax was accounted for.

The debit or credit note must be issued, whether or not the supplier accounts for tax on an invoice or payments basis. The issue of a credit note is not required when a prompt payment (settlement) discount is the reason for the reduction in the consideration, provided the terms of that discount are clearly shown on the tax invoice.

CHAPTER 15

ADJUSTMENTS

15.1 INTRODUCTION
This chapter identifies those situations in which a vendor will be required to make adjustments to input tax or output tax. It explains when the adjustments should be made by the vendor and what the amounts of the adjustments should be.
Adjustments to input tax or output tax will arise in respect of taxable supplies, for example, where –

• an irrecoverable debt is written off by a vendor;
• a debit or credit note is issued or received by a vendor;
• early payment of an account gives rise to a prompt settlement discount;
• faulty goods received by the customer are returned to the supplier; and
• a change in the extent of taxable use or application of goods or services occurs.

15.2 IRRECOVERABLE DEBTS
A vendor who accounts for VAT on the invoice basis may deduct input tax in respect of debts which have become irrecoverable. In the exceptional case of a vendor who is registered on the payments basis and who has already accounted for a taxable supply which was paid with a cheque and the cheque is dishonoured, that vendor may also deduct input tax. The circumstances under which such a deduction may be claimed, requires firstly that there must have been a taxable supply for a consideration in money. Secondly, the vendor must already have accounted for the supply in a VAT return. Only then is that vendor entitled to make an input tax adjustment. The adjustment is calculated by applying the tax fraction (14/114) to the amount actually written off as input tax.

A debt will be considered as irrecoverable if both the following requirements have been complied with, namely:

• The vendor must have done all the necessary entries in the accounting system to record that the amount has been written off.
• The vendor must have ceased active recovery action on the debt or handed the debt over to an attorney or debt collector.

The vendor may then make an input tax deduction in the tax period in which both of the abovementioned requirements have been met. In the case where the vendor subsequently receives payment in respect of a debt written off as irrecoverable, the vendor must account for output tax on the payment in the tax period in which the payment is received.