Three conditions govern a bad debt deduction under s25-35 ITAA 1997. The debt must have been included in assessable income. It must be genuinely unrecoverable. And the write-off must be formally recorded before 30 June. Miss any one condition, and the deduction falls away. Blackwattle Tax is a chartered accounting firm advising accrual-basis companies on ATO compliance obligations under s25-35.
What Qualifies as a Bad Debt Under ATO Rules
A bad debt deduction reduces assessable income in the year the debt is written off. The year it became overdue is irrelevant. Taxation Ruling TR 92/18 sets the standard. The debt must be a presently enforceable obligation.
The creditor must have determined it will not be recovered. Accounting estimates and doubtful debt provisions do not meet that threshold. A write-off decision recorded on 29 June produces a deductible claim. The same decision made on 3 July produces nothing.
Bad Debt vs Doubtful Debt: The Distinction That Kills Deductions
A doubtful debt provision is not tax-deductible. Only a debt formally written off as bad satisfies s25-35 ITAA 1997. The write-off must occur in the income year of the claim. More deductions are lost here than anywhere else.
Doubtful Debt Provision | Bad Debt Write-Off | |
Nature | Accounting estimate of future losses | Specific decision about a specific debt |
Tax treatment | Not deductible | Deductible under s25-35 |
ATO stance | Rejected as a deduction basis | Accepted if the three conditions are met |
Can be reversed | Yes, a provision can be unwound | Recovery triggers income inclusion under s20-20 |
Documentation required | None beyond accounting entry | Written decision + accounting entry |
Many companies carry a general provision for doubtful debts. That provision has no tax effect on its own. A specific debt must be removed from accounts receivable through a formal write-off decision. That decision must name the debtor, the amount, and the commercial basis. At that point, the deduction becomes available.
Three Conditions That Must All Be Met Before 30 June
All three conditions under s25-35 must be satisfied at the same time. The debt must be in assessable income. It must be genuinely bad. And it must be written off before the income year ends. Satisfying two out of three is not enough.
Condition 1 – The Debt Must Have Been Previously Included in Assessable Income
A deduction cannot be created for income that was never declared. This is the most frequently misunderstood condition.
Consider two companies with the same $20,000 unpaid debt. Company A operates on an accruals basis. The invoice was included in the 2024–25 assessable income. The debtor entered voluntary administration.
If Company A writes off the debt before 30 June, the deduction is available. Company B operates on a cash basis and has never declared income. No deduction exists. The amount must appear in a tax return before a write-off creates a deductible expense.
Condition 2 – The Debt Must Be Genuinely Bad, Not Merely Overdue
A debt is bad when commercial judgment determines recovery is unlikely through any reasonable means. Legal proceedings are not always required. The ATO expects recovery attempts proportionate to the debt size.
Acceptable evidence includes the debtor being in liquidation with no assets, being untraceable, or recovery costs exceeding the debt value. An overdue invoice does not qualify. A disputed debt under active negotiation does not qualify. The judgment must be documented at the time of write-off. A retrospective assessment will not satisfy the ATO.
Condition 3 – The Debt Must Be Formally Written Off Before 30 June
Two elements are both required. First, an authorising document. Second, a corresponding accounting entry. Neither alone is enough. For companies, a director’s resolution is the most defensible form. It must name the specific debts, amounts, and commercial basis for each determination.
The accounting entry, Debit Bad Debt Expense, Credit Accounts Receivable, must be processed before 30 June. Backdating a write-off is not acceptable. The ATO’s compliance program specifically targets this.
What Directors Must Do Before 30 June
Directors who miss the 30 June deadline lose the deduction entirely. The debt can be clearly unrecoverable and still produce no deduction if the write-off was not documented in time.
Before 30 June, companies should:
- Export the aged receivables report and identify debts outstanding beyond 90 days
- Apply the three-condition test to each flagged debt
- Prepare a director’s resolution naming specific debtors, amounts, and the commercial basis
- Process the journal entry, Debit Bad Debts Expense, Credit Accounts Receivable, before 30 June
- Retain supporting evidence: debtor correspondence, formal demands, insolvency notices
- Assess GST adjustment eligibility for each written-off amount
For companies with related-party debts or post-restructure ownership, tax compliance advice for accrual-basis companies at Blackwattle Tax covers the additional requirements that apply.
GST Adjustment on Written-Off Debts
An accruals-basis company registered for GST can claim a decreasing adjustment when it writes off a bad debt. The adjustment recovers GST already remitted on the unpaid invoice. Three conditions apply.
The original sale was taxable. GST was already paid. And the debt has been written off or outstanding for 12 months or more. The adjustment equals 1/11th of the amount written off (GSTR 2000/2). If the debt is later recovered, an increasing GST adjustment applies in that BAS period.
Company-Specific Rules: Continuity of Ownership and the Business Continuity Tests
Companies have an additional requirement beyond the three conditions. They must satisfy the continuity of the ownership test. Where ownership has changed, a business continuity test applies instead. The applicable test depends on when the debt was incurred, not when it is written off. For debts before 1 July 2015, the same business test (TR 1999/9) applies.
For debts from 1 July 2015 onwards, the similar business test under LCR 2019/1 is also available. Companies that have gone through acquisition or shareholding changes must check their debt dates carefully. The corporate tax advisory services at Blackwattle Tax include continuity of ownership assessments for pre-EOFY receivable reviews.
When Bad Debt Deductions Attract ATO Scrutiny
The ATO’s compliance program targets two categories of bad debt claims. First, claims without adequate documentation. Second, claims involving related parties. Director loans, shareholder loans, and intercompany receivables face heightened scrutiny. They can be structured to manufacture artificial deductions.
A director loan write-off may also trigger Division 7A consequences if not properly assessed beforehand. The most common disallowance reason is documentation deficiency. A write-off that cannot be traced to a written decision made before 30 June will fail substantiation.
Review Your Bad Debt Position Before 30 June
A valid bad debt deduction requires three things. A formal written decision. A corresponding accounting entry. And adequate substantiation, all before 30 June. Blackwattle Tax assesses accrual-basis receivables against s25-35 conditions, prepares director’s resolutions, and reviews continuity of ownership positions.
Book a complimentary 30-minute strategy session with one of our directors. ATO compliance advisory for mid-market companies at Blackwattle Tax is available now, before the end of the financial year.
Frequently Asked Questions
Can a company claim a bad debt deduction without commencing legal proceedings?
Legal proceedings are not required. The ATO expects recovery attempts proportionate to the debt size. A commercial decision that legal action would cost more than the debt value is sufficient. That reasoning must be documented at write-off.
What happens if a written-off debt is later recovered?
Under s20-20 ITAA 1997, the recovered amount is included in assessable income in the year of receipt. A corresponding increasing GST adjustment applies if a decreasing adjustment was claimed at write-off.
Do related-party debts face a different standard?
The three-condition test under s25-35 applies to all debts. Related-party write-offs attract heightened ATO scrutiny. A director loan write-off may interact with Division 7A in ways that generate separate tax consequences. Specific advice before processing any related-party write-off is essential.
Disclaimer: This article provides general information only and does not constitute legal or tax advice. For personalised guidance, consult a registered tax agent.
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Disclaimer: We endeavour to make sure the information provided in this guidance is up to date and accurate. Please note, that the information is only intended to be a guide, with a general overview of information. This guidance is not a comprehensive document and should not be interpreted as legal advice or tax advice. The information is general in nature. You should seek the assistance of a professional opinion for any legal and tax issues related to your personal circumstances.