Bad debts generate more bookkeeping complexity per dollar than almost any other transaction type. A single irrecoverable invoice sets off a chain of interlinked obligations: a tax deduction under the income tax legislation (subject to strict qualifying conditions), a separate GST adjustment on the BAS (available only in the period of write-off), and a reversal of both if the debt is later recovered. Each step has its own timing rule and its own consequences for mishandling.
When Is a Debt "Bad" for Income Tax Purposes?
Section 25-35 of ITAA 1997 allows a deduction for a debt that is "bad" — but the ATO's TR 92/18 makes clear that a debt is not bad merely because it is overdue, or because the debtor is slow to pay, or because a dispute is ongoing. The creditor must satisfy the following:
- The creditor has taken all reasonable steps to recover the debt commensurate with the amount involved.
- The creditor has formed the genuine belief that further recovery action is unlikely to result in payment.
- The debt has been formally written off in the accounts in the income year for which the deduction is claimed.
A general provision for doubtful debts — a balance sheet reserve — is not a tax deduction under s.25-35. Only the actual write-off qualifies. A business that maintains a doubtful debts provision without formally writing off specific identifiable debts will have no deduction to claim at year-end. This distinction between a provision and a write-off is one of the more commonly misunderstood rules in small business tax practice.
The write-off must be evidenced by a management decision — a board minute, a formal creditor decision document, or at minimum a memo from the business owner or director approving the write-off of a specific debt. This documentation is required to support the deduction if the ATO queries the return.
The GST Adjustment on Write-Off
Division 21 of the GST Act provides a separate mechanism by which a supplier who has accounted for GST on a supply (and has remitted that GST to the ATO) can reduce their GST liability when the consideration for that supply becomes a bad debt.
The adjustment is 1/11th of the written-off amount — the GST component embedded in the invoiced price.
Critical timing: the GST adjustment is available only in the BAS period in which the debt is formally written off in the creditor's accounts. If a debt is written off on 28 June (the last business day of the June quarter), the adjustment belongs in the June quarter BAS. If the write-off is processed on 1 July (the first day of the September quarter), the adjustment belongs in the September quarter BAS — even if the debt was clearly irrecoverable before 30 June. There is no retrospective claim or carryback.
The adjustment is reported at label G18 on the BAS. The amount entered at G18 is the GST-exclusive amount of the written-off debt; the BAS system then applies 1/11 to arrive at the GST credit. Some BAS preparers incorrectly enter the full GST-inclusive amount or the GST component itself — always check the label instructions.
The GST adjustment under Division 21 is only available to suppliers who are on an accruals (invoice) basis for GST. If the entity is on a cash basis, no GST was remitted on the invoice until payment was received — so there is no prior GST liability to reverse.
Maintaining a Bad Debt Register
A bad debt register is the practical tool for managing these obligations. At a minimum, the register should capture for each written-off debt:
- Debtor name and invoice number
- Original invoice date and invoice amount (GST-inclusive)
- GST component
- Date of write-off (month-end or specific date)
- BAS period in which the G18 adjustment was made
- Whether recovery steps were documented and by whom
The register should be reconciled to the BAS each quarter to confirm that adjustments made at G18 correspond to debts formally written off in that period. Discrepancies between the write-off date in the accounts and the G18 claim period are a common source of BAS errors.
Recovery of a Written-Off Debt
If a debt is recovered after having been written off, two obligations arise simultaneously:
Income tax: Under s.20-20 of ITAA 1997, the recovered amount (or the portion that was previously written off and deducted) is assessable income in the year of recovery. If the debt was partially written off and a full recovery is made, only the previously written-off portion is assessable — the balance merely reduces the outstanding receivable.
GST: Under s.21-10 of the GST Act, where a GST adjustment was made under Division 21 at the time of write-off, and the debt (or part of it) is subsequently recovered, the recovering party must increase their GST liability in the BAS period of recovery. The increase is 1/11th of the recovered amount. This is reported at label G15 on the BAS (increasing adjustments). There is no discretion about timing — the GST adjustment occurs in the period the money is received.
Practical Bookkeeping Setup for Ongoing Management
At the account level, maintain:
- Trade debtors — the live receivables ledger.
- Bad debts written off — an expense account (not a contra to trade debtors) where formally written-off amounts are posted.
- Bad debt recoveries — a separate income account for amounts subsequently received against previously written-off debts.
Each month, review aged debtors beyond 90 days. Flag accounts meeting the TR 92/18 criteria for management review. On formal write-off approval, post the write-off journal (debit Bad Debts Written Off, credit Trade Debtors) and schedule the G18 adjustment in the current-period BAS. If a recovery is received in a later period, post it to Bad Debt Recoveries income and schedule the G15 adjustment in the recovery-period BAS.
This treatment ensures the income tax position (write-off year vs. recovery year), the BAS GST adjustments (write-off period vs. recovery period), and the balance sheet (clean trade debtors ledger) all remain consistent and auditable.