Bad Debt Write-Offs vs Commercial Debt Forgiveness: Tax and Bookkeeping Differences

Last reviewed against current ATO guidance: 04 Dec 2026. Always confirm current thresholds, rates, and dates at ato.gov.au.

Businesses write off uncollectible debts as a routine part of managing receivables. But there's a significant difference between a bad debt write-off (an accounting and tax adjustment for an unrecoverable amount) and commercial debt forgiveness (a deliberate decision to release a debtor from their obligation). The two have different income tax treatment, different GST consequences, and different journal entry requirements.

Bad Debt Write-Off

A bad debt arises when a receivable becomes genuinely uncollectible — the debtor is insolvent, has disappeared, or the cost of recovery exceeds the likely recovery. The creditor doesn't choose to release the debt; they simply acknowledge it won't be collected.

Income Tax Treatment

Under section 25-35 of the ITAA 1997, a bad debt deduction is available when:

1. The debt is actually written off in the accounts during the income year
2. The debt was previously included in assessable income (accruals accounting), or the business is carrying on a business of lending money
3. The debt is genuinely bad (not merely doubtful)

The write-off must be actual, not merely a provision. A "provision for doubtful debts" does not give rise to a deductible bad debt — the ATO is explicit about this. The debt must be removed from the debtor's account.

GST Adjustment on Bad Debts

This is the step most commonly missed. When a GST-registered business makes a taxable supply on accruals (non-cash) accounting, it accounts for GST in the period of supply — before receiving payment. If the debt subsequently becomes bad and is written off, the business is entitled to a decreasing adjustment (effectively a GST refund) equal to the GST component of the bad debt.

Conditions for the GST adjustment (Div 21 GST Act):

• The supply was taxable
• The supplier accounted for GST on a non-cash (accruals) basis
• The debt (or part of it) has been written off as bad
• At least 12 months have passed since the supply OR the debtor is insolvent (both conditions not required — either suffices for the 12-month waiver)

The adjustment is:

Decreasing Adjustment = Bad Debt Amount × 1/11

For a $5,500 bad debt (GST-inclusive), the adjustment is $500.

Journal entry at write-off:

DR  Bad Debt Expense                    $5,000
DR  Bad Debt — GST Adjustment (or ATO)    $500
    CR  Accounts Receivable                 $5,500

On the BAS: include the $500 at label 1B (other credits) or specifically at the GST adjustments label, depending on your BAS software. This reduces the net GST remittable for the quarter.

If payment is later received on a previously written-off debt, the GST adjustment reverses and must be disclosed as an increasing adjustment on the BAS for that period.

Bad Debt Journals

Full write-off (no allowance account):

DR  Bad Debt Expense                    $X,XXX
DR  GST Adjustment                        $XXX
    CR  Accounts Receivable                 $X,XXX

Using an allowance for doubtful debts account:

Period end (provisioning):

DR  Doubtful Debt Expense               $X,XXX
    CR  Allowance for Doubtful Debts        $X,XXX

At actual write-off:

DR  Allowance for Doubtful Debts        $X,XXX
DR  GST Adjustment                        $XXX
    CR  Accounts Receivable                 $X,XXX

Note: the provision in the first entry is not deductible for income tax. Only the actual write-off in the second entry triggers the s25-35 deduction.

Commercial Debt Forgiveness

Commercial debt forgiveness is a deliberate act — the creditor chooses to release the debtor from part or all of an obligation. Unlike a bad debt, the creditor isn't acknowledging irrecoverability; they're making a commercial decision, often in a restructuring or related-party context.

The Forgiven Amount Rules (Division 7A and Subdivision 245)

Subdivision 245 of the ITAA 1997 governs commercial debt forgiveness. When a debt is forgiven:

1. The creditor cannot claim a deduction for the forgiven amount — it's not a bad debt
2. The debtor must reduce certain tax attributes (carried-forward losses, cost bases of assets, deductible amounts) by the net forgiven amount

The net forgiven amount is broadly the face value of the debt less any amount included in the debtor's assessable income.

The Impact on the Debtor

For the debtor entity, the consequences of debt forgiveness are not immediately taxable in most cases — the debt is not income. Instead, Subdivision 245 requires the debtor to reduce tax attributes in a specific order:

1. Prior year tax losses
2. Current year tax losses
3. Net capital losses
4. Cost bases of CGT assets
5. Deductible expenditure not yet incurred

Only if these attributes are exhausted does any remaining net forgiven amount become assessable income. This order is automatic and cannot be elected.

This means a debtor with significant carried-forward losses may experience no immediate cash tax consequence from forgiveness — the losses are simply reduced.

Related Party Debt Forgiveness

Related-party debt forgiveness (e.g., a company writing off a loan to a director or shareholder) requires care:

• If the debt is forgiven by a private company to a shareholder or associate, Division 7A deems the forgiveness to be an unfranked dividend — assessable to the recipient in full
• If the debt is forgiven by a trust to a beneficiary, the analysis depends on whether the beneficiary had assessable income from the trust in the relevant year

Journal Entries for Debt Forgiveness

For the creditor:

DR  Debt Forgiveness Expense (non-deductible)   $X,XXX
    CR  Loans Receivable / Debtors                  $X,XXX

No GST adjustment arises on commercial debt forgiveness — the GST adjustment provisions in Div 21 apply only to bad debts, not consensual releases. (Though if the forgiveness relates to a supply that has already been taxed, confirm with a specific ruling for complex arrangements.)

For the debtor:

DR  Loans Payable / Creditors           $X,XXX
    CR  Debt Forgiveness Reserve (equity)    $X,XXX
    (or CR Assessable Income if tax attributes exhausted)

Practical Reconciliation Considerations

In ReconLink, bad debt write-offs typically appear as internal adjustments rather than bank transactions — they don't appear in an imported bank statement unless a recovery payment is received. The critical step for BAS agents is to ensure the GST adjustment is captured each quarter when debts are written off. A period-end checklist item should ask: "Were any invoices written off this quarter? If yes, calculate and include the GST decreasing adjustment."

For debt forgiveness arrangements, document the legal deed of release, confirm the parties involved, and check whether Division 7A applies before booking any entries. The absence of documentation makes ATO audit findings significantly harder to defend.