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How to Charge Interest on Unpaid Invoices (The Legal Way)

Unpaid invoices are a big deal, especially when you are running a small business or are self employed. Consequently, they can cost you your cash flow and your reputation with your own suppliers. More importantly, they can cause disappointment from broken promises. How you deal with late payers can have a huge impact on your business. Fortunately, the good news is, there is a legal way to charge interest on unpaid invoices. Read more to find out how and when to issue late payment interest to clients.

The Legal Definition of When a Payment Becomes Late

As with any legal matter, there are statutory rules that determine when an invoice is considered late. This is crucial because this is needed to calculate the amount of late interest that can be charged.  According to the rules, an invoice becomes late from the point where:

  • Payment has not been received in accordance with payment terms clearly set out on the invoice or contract;
  • In the absence of any payment terms, the payment is considered late after 30 days for public authorities and 60 days for business transactions after either:
    • the customer gets the invoice or;
    • you deliver the goods or provide the service (if this is later).

Who Can You Charge Late Payment Interest To

Interest on unpaid invoices can be charged only on business to business transactions. Therefore, if you have supplied something to a consumer you are unable to charge interest on any late payments.

Late Payment Interest Rate

The interest rate on unpaid invoices is set by law.  Currently, it’s 8% over the Bank of England base rate.  

You can find the Base Rate of Interest on the Bank of England website HERE, but it is set at 0.5% as of November 2017.

Debt Recovery Costs

In addition to late payment interest, you can also claim a fixed amount for debt recovery. The amount you can claim is based on the gross invoice value:

Amount of debt What you can charge
Up to £999.99 £40
£1,000 to £9,999.99 £70
£10,000 or more £100

How to Calculate Late Payment Interest on an Unpaid Invoice

The interest on late payments is calculated from the point that the unpaid invoice became due for payment on a daily basis.

For example, if you are owed £1,000 and the Bank of England base rate is 0.5%:

  • the annual statutory interest on this would be £85 (1,000 x 0.085 = £85)
  • divide £85 by 365 to get the daily interest: 23p a day (85 / 365 = 0.23)
  • after 50 days this would be £11.50 (50 x 0.23 = 11.50)

In addition, you can charge £70 for debt recovery costs so the total that is now due is £1,081.50.

VAT and Late Payment Interest

If you are VAT registered, interest is calculated on the gross invoice value.  However, the interest charge itself is outside the scope of VAT as this is considered a credit charge.

How to Invoice for Late Payment Interest

If you need to charge your customer for late payment interest, then your first step is to contact them in writing advising them that you are going to begin charging late payment interest until the point that the unpaid invoice is paid.  You should provide them with details of the invoice, outstanding amount, how you chased the debt and the interest charge.

Once you customer has paid, you should raise a final invoice. This should include the original debt amount and the interest which has been applied, detailing how it was calculated.

Should You Charge Late Payment Interest on Unpaid Invoices

Deciding whether you should issue a late payment interest is a business decision that you should consider carefully:

  • You could erode a valuable business relationship;
  • Late payment interest, when done correctly, is legally enforceable. However, extracting it from your customer can be a different matter. You could find yourself fighting for a relatively small amount of money but recovering the full debt;

Finally, if you find that you are experiencing slow late payments on a regular basis, then consider looking at your invoicing system and whether you need to make some business financing improvements.

10 Steps to Setting Up the Perfect Invoicing System