Getting Paid: Handling Invoices and Bad Debts – A Complete Guide by a Montreal CPA Firm Near You

Introduction

For self-employed Canadians—freelancers, consultants, contractors, tradespeople, gig workers—getting paid is just as important as doing the work itself. But many new business owners discover that not every client pays reliably. Unpaid invoices (bad debts) can create major cash-flow problems and significantly impact profitability. Fortunately, CRA allows sole proprietors to deduct bad debts—but only under strict conditions. Many taxpayers misunderstand these rules and either fail to claim eligible bad debts or attempt to deduct amounts that CRA later denies. Understanding how to invoice properly, how to document unpaid receivables, and how to deduct bad debts correctly ensures financial stability and CRA compliance.

Legal and Regulatory Framework

Bad debt deductions for sole proprietors are governed by the Income Tax Act, primarily:

• Section 9(1) – income must be computed using normal business principles
• Section 18(1)(a) – expenses must be incurred for the purpose of earning income
• Section 20(1)(p) – specifically allows the deduction of bad debts from business income
• CRA’s T2125 instructions – business receivables and bad debts must be reported properly

To deduct a bad debt:

1. The amount must have been included in your business income previously.

2. The receivable must be uncollectible despite reasonable efforts to collect.

3. You must maintain documentation of invoices, reminders, emails, payment demands, and collection efforts.

4. The debt must be written off in your books.

Bad debts are reported on Form T2125, reducing your net business income for the year. These rules form the legal foundation for deducting bad debts as a self-employed individual in Canada.

Key Court Decisions

Canadian courts emphasize the need for evidence and commercial behaviour when deducting bad debts.

In S. Wong & Associates v. Canada, CRA denied a bad debt claim because the taxpayer failed to show collection efforts. The court affirmed that businesses must prove they tried to recover the receivable.

In Ristorante a Mano v. The Queen, a business successfully deducted bad debts because it maintained clear documentation of invoices, demand letters, and attempts to negotiate payment.

In White v. Canada, an uncollectible debt was disallowed because the taxpayer never included the amount in income; the court reinforced that only previously recognized receivables qualify.

In Kingsley v. Canada, poor invoicing habits led to rejected bad debt claims, demonstrating that proper invoicing is essential.

These cases show that CRA looks closely at documentation and commercial intent when evaluating bad debt deductions.

Why CRA Targets This Issue

CRA regularly reviews bad debt deductions because they are often misused. CRA flags:

• bad debts claimed without showing they were ever included in income
• receivables written off too quickly
• “bad debts” that are actually personal loans to clients or friends
• lack of invoices, contracts, or written agreements
• large write-offs relative to business revenue
• missing attempts to collect the debt
• attempts to write off unpaid deposits (not allowed unless previously declared as income)

CRA also compares bank deposits to reported income and checks for inconsistencies. Because bad debt deductions reduce taxable income, CRA treats this area as high-risk.

Mackisen Strategy

At Mackisen CPA Montreal, we help self-employed clients set up a disciplined invoicing, collection, and bad-debt tracking system. Our structured approach includes:

1. Building an Audit-Proof Invoicing System

• proper invoice numbering
• client details and payment terms
• due dates and late-payment interest
• GST/HST/QST charges (if registered)

2. Implementing Collection Protocols

• reminder emails at 7, 14, and 30 days past due
• written payment demand at 60 days
• optional use of small claims court or collection agencies for large debts

3. Determining When a Debt Is Truly Uncollectible

• client has disappeared
• client refuses to pay and communication has ceased
• contract dispute clearly resolved in your favour
• legal action is unlikely to result in recovery

4. Filing a Deductible Bad Debt

• writing off the receivable in your bookkeeping
• documenting all collection attempts
• deducting the amount in your T2125 under “Bad debts”
• ensuring the receivable was previously included in income

5. Integrating Cash-Flow and Tax Planning

• recommending deposits or retainers to reduce risk
• helping clients avoid future non-payment situations
• assisting with small claims filings if necessary

This structured method ensures CRA compliance while protecting your cash flow.

Real Client Experience

A freelance videographer completed a $6,000 project but never got paid. CRA initially denied his bad debt claim due to lack of documentation. We recreated the paper trail—contract, emails, payment reminders—and the deduction was reinstated.

Another client, a consultant, tried to deduct unpaid invoices as bad debts, but she had never recorded them as income. CRA denied the deduction. We corrected her bookkeeping to ensure proper accrual accounting going forward.

A web designer repeatedly faced late-paying clients. We implemented a deposit-based invoicing system, eliminating future bad debt deductions entirely and stabilizing her cash flow.

Common Questions

Self-employed taxpayers often ask whether deposits can be written off. No—only amounts already included in income qualify.
Others ask whether small unpaid invoices should be written off. Yes—if collection efforts have failed and documentation exists.
Some ask whether bad debts can create a business loss. Yes—if expenses exceed income.
Another question: Can cash-basis self-employed taxpayers deduct bad debts? No—only accrual-basis income qualifies.

Why Mackisen

With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps freelancers and sole proprietors manage receivables, prevent cash-flow disruptions, and properly deduct bad debts. Whether you need invoicing support, compliance review, or CRA defence, our expert team ensures precision, transparency, and full audit protection.