Credit Notes and VAT/GST: How Tax Adjustments Work
A credit note corrects an invoice — but for VAT/GST-registered businesses, it also corrects the tax. The mechanism is a mirror: when you credit an overcharge, you reduce your output tax and your client reduces the input tax they claimed. Every tax authority we cover has its own documentation rules for that mirror to work legally. Get the document wrong and one side of the mirror breaks — you'll have claimed tax back you weren't owed, or your client will.
This guide covers the UK, Australia, Canada, and the US in detail. For the document itself — what a credit note must contain, numbering, and worked layouts — see how to write a credit note.
The basic mechanism
Every VAT/GST system works the same way at the core:
- Supplier (you): the credit note lets you reduce the output tax you owe on the original invoice. You claim the reduction in the tax period when the credit note is issued.
- Recipient (your client): if they're registered, they must reduce the input tax they claimed, in the tax period when the credit note is received.
Both sides must hold the right document for their side of the adjustment. The rest of this guide is about what that document must be, and how quickly you must produce it.
United Kingdom: HMRC's 14-day rule
UK law (the VAT Regulations 1995, regulation 15C) is the most prescriptive of the four countries. When consideration for a supply decreases — an overcharge corrected, a discount agreed — the supplier must issue a credit note no later than the end of the 14-day period beginning with the day the decrease occurs.
The credit note must show:
- Its own identifying number and date of issue
- Your name, address, and VAT registration number
- The client's name and address
- The number and date of the original VAT invoice
- A description identifying the goods or services
- The amount credited, excluding VAT
- The rate and amount of VAT credited — in sterling, even if the original invoice was in another currency
Two further UK details catch freelancers out:
- "Real world" value. Since September 2019, you can only reduce your output VAT when the credit gives the client genuine value — meaning you've actually repaid them or offset the credit against their other unpaid invoices. Issuing a credit note and leaving the money in your pocket doesn't count. If you agree to repay in instalments, issue a credit note for each repayment as it's made.
- No VAT adjustment, no VAT credit note. If you and your VAT-registered client agree not to adjust the VAT on the credit, the document must state "This is not a credit note for VAT" — and you still adjust the net figures on your VAT returns.
UK worked example
Ammar Shafi, a freelance web developer in Manchester (VAT-registered), invoiced "Brightline Ltd" £3,000 plus 20% VAT = £3,600 on 2 October 2026 (INV-2026-0038). On 8 October he discovers a £300 overcharge (net). He issues credit note CN-2026-0007 within 14 days, showing:
- Amount credited excluding VAT: £300
- VAT credited at 20%: £60
- Total credit: £360 (in sterling)
- Original invoice: INV-2026-0038, dated 2 October 2026
Ammar repays the £360 to Brightline's account. On his VAT return for the period covering 8 October, he reduces output VAT by £60. Brightline, having received the credit note, reduces its input VAT claim by £60 in the period it received it.
Australia: ATO adjustment notes
Australia doesn't technically call the document a credit note for GST purposes — it's an adjustment note. Under ATO ruling GSTR 2013/2, when an "adjustment event" (an overcharge corrected, a price reduction, returned goods) decreases the GST on a sale, the supplier must issue an adjustment note so both parties can attribute their adjustments on their BAS.
Key Australian rules:
- You must hold an adjustment note to claim a decreasing adjustment on your GST return — for both the supplier and the recipient. No adjustment note, no adjustment.
- The $75 exception. If the decreasing adjustment is $75 or less (GST-inclusive), no adjustment note is required.
- Increasing adjustments never need an adjustment note — only decreases do.
- Bad debts don't qualify. Writing off an unpaid invoice is not an adjustment event, so adjustment-note rules don't apply — chase the debt instead.
- An adjustment note must show the difference between the price of the supply as it was and as it now is (or the GST-exclusive difference, with GST amount ascertainable), and identify the original tax invoice.
Australia worked example
Mia, a freelance designer in Melbourne (GST-registered), invoiced a client $2,200 including GST — so GST was $200 (one-eleventh of the GST-inclusive price). After invoicing, she agrees a $330 GST-inclusive discount because a project phase was dropped. The GST on that reduction is $30 (one-eleventh of $330). Because $330 exceeds the $75 threshold, Mia must issue an adjustment note referencing the original tax invoice. On her next BAS, she claims a decreasing adjustment of $30. Her client reduces their input tax credit by $30 in the period they receive the note.
Canada: CRA section 232
In Canada, the rules come from section 232 of the Excise Tax Act. The CRA's position is straightforward and worth quoting: no adjustment to net tax is permitted unless a credit note (or debit note) is issued. In other words, the document is the gate — without it, neither side gets to adjust their GST/HST.
Canadian rules:
- No fixed deadline, but act within a reasonable time. Unlike the UK's 14 days, Canada requires the credit note within a "reasonable time" after the refund, adjustment, or credit is made. Don't test that phrase — issue it promptly.
- Prescribed information required. The credit note must identify the original invoice and show the tax amount credited. If the original invoice stated that the amount included GST/HST, the credit note should state that the credit includes the tax too.
- How it's reported. The supplier deducts the credited tax when working out net tax for the reporting period in which the credit note is issued — recorded as an adjustment on line 107 of the GST/HST return. The recipient (if a registrant) adds the amount back when working out net tax for the period in which the credit note is received — recorded on line 104.
Canada worked example
Devon, a freelance developer in Toronto (GST/HST-registered), invoiced a client $4,000 plus 13% HST = $4,520 (DEV-2026-0017). He finds a $500 overcharge (net). He issues a credit note promptly, referencing DEV-2026-0017, showing the HST credited at 13% = $65. On the GST/HST return covering the credit note's issue date, Devon deducts $65 on line 107. The client, on receiving the credit note, adds $65 back on line 104 of the return covering that period.
United States: no federal credit-note statute
There is no US federal law governing credit notes — they're a matter of good accounting practice, not statute. The tax side is sales tax, which is state-level:
- When you credit part of a sale, adjust the sales tax on the credited amount in the sales tax return for the period the credit was issued, following your state's rules.
- Most states let you reduce taxable sales by the credited amount on your return; a few require you to actually have refunded the customer first.
- Keep the credit note as your supporting document — if you're audited, it's the evidence that your reported taxable sales legitimately dropped.
- For multi-state sellers, apply the rules of the state where the sale was sourced.
For the US sales-tax basics behind all of this, see our US sales tax guide.
Mistakes that break the tax adjustment
- Credit-noting a bad debt. The supply happened, so no VAT/GST adjustment is due. In the UK this is explicitly disallowed; in Australia bad debts aren't adjustment events at all.
- Adjusting output tax without giving value (UK). Issuing the credit note but keeping the money — since September 2019, the VAT reduction only follows an actual repayment or offset.
- Missing the 14-day window (UK). Issue the credit note within 14 days of the decrease occurring, or your VAT return adjustment lands in the wrong period.
- No adjustment note on a large correction (Australia). Above $75 GST-inclusive, both sides need it — without it, neither side's adjustment is valid.
- Adjusting net tax without issuing the note (Canada). The CRA is explicit: no credit note, no line-107 deduction.
- Forgetting the sterling rule (UK). VAT credited must be shown in pounds sterling even when the original invoice was in dollars or euros — a common miss on international invoices. See our UK VAT invoice guide for the full multi-currency rules.
FAQ
Do I issue the credit note or adjust my tax return first? Issue the credit note first, then reflect it on your return. The document is the evidence for the adjustment — in every country here, the timing of the credit note determines which tax period the adjustment belongs to.
My client isn't VAT/GST registered. Do I still adjust? Yes on your side: you reduce your output tax on the credited amount. The client has no input tax to unwind, so they simply owe you less. In Canada, the "recipient must add back" rule only applies to registrants.
What if the original invoice and the credit note fall in different tax periods? That's normal and expected — the adjustment always belongs to the period when the credit note is issued (supplier) or received (client), not the period of the original invoice. Nothing gets re-filed for the old period.
Can I credit-note an invoice from last financial year? Yes — as long as the invoice was wrong or the consideration genuinely decreased. The adjustment goes in the current period. This is precisely why you issue a credit note instead of voiding a sent invoice: voiding a closed-period invoice would require re-opening history.
Do I need a separate credit note series for each currency? You don't have to, but keep the rules straight per currency. The UK's sterling-only rule for the VAT amount is the one that most often collides with multi-currency invoicing — show the foreign-currency credit and the sterling VAT figure on the same document.