Setting Up Your AR Process
A strong accounts receivable system starts before you invoice:
- Credit terms in writing: your engagement letter or contract should specify payment terms (Net 15, Net 30, 50% deposit)
- Clear invoices: include invoice number, date, due date, HST number, and line-item breakdown
- Automated reminders: QuickBooks, Wave, and FreshBooks all support automatic follow-up emails at 7, 14, and 30 days
- Aging report review: review AR aging weekly — know exactly which clients owe what and for how long
GST/HST Implications of Unpaid Invoices
If you file GST/HST on an accrual basis, you owe the tax when you issue the invoice — even if the client never pays. This is a common cash flow trap.
Options for dealing with this:
- Switch to cash basis: eligible if annual taxable revenues are under $1 million — you only remit GST/HST when you actually receive payment
- Claim a bad debt adjustment: if you've already remitted GST/HST on an invoice that later becomes uncollectible, you can recover the GST/HST portion by filing a bad debt adjustment (Line 107 on your GST34 return)
Writing Off Bad Debts for Income Tax Purposes
A debt becomes a "bad debt" when you can demonstrate it is uncollectible. The CRA requires:
- The debt was included in income (i.e., you used accrual accounting and reported the sale)
- You have taken reasonable collection steps
- You have determined the debt is uncollectible
Once written off, the bad debt is deductible as a business expense. Keep records of collection attempts (emails, letters, collection agency). If the debt is later collected, it must be included in income in the year received.
When to Use a Collection Agency or Small Claims Court
For invoices under $35,000 in Ontario ($20,000 in Quebec), Small Claims Court is an affordable option. Court fees start around $100–$200 and you don't need a lawyer.
Before escalating:
- Send a formal demand letter stating you will proceed to court if not paid within 10 days
- Consider a collection agency for invoices under $5,000 — typically 25–33% of the amount collected
- Check whether your business interruption insurance covers bad debts (some policies do)
Frequently Asked Questions
Yes — your standard engagement letter should include a late payment interest clause (typically 1.5–2% per month, compounded monthly). This creates a legal basis to charge interest and often motivates faster payment. You must charge GST/HST on interest income if it relates to a taxable supply.
No. Bad debt deductions are only available to businesses that use accrual accounting and have already included the unpaid amount in income. Cash-basis filers never recognized the revenue, so there's nothing to deduct.
The CRA requires you to keep business records for 6 years from the end of the last tax year to which they relate. This includes invoices, collection correspondence, and bad debt write-off documentation.
A write-off removes the full amount from AR (deemed uncollectible). A write-down reduces the value to reflect the expected recoverable amount. The CRA generally requires a full write-off before allowing the deduction.