What is a credit note and when do you issue one?

A credit note cancels or reduces an invoice you have already issued. You use one instead of deleting or editing the original, because the original has to stay in the record.

You overcharged, the client returned something, or you raised the invoice against the wrong entity. The fix is never to quietly delete invoice 1043 — that leaves a gap in your sequence and an unanswerable question in an audit.

Instead issue a credit note referencing invoice 1043, for the amount being cancelled, with its own number in its own series. If tax was charged on the original, the credit note reverses that tax too.

Then, if needed, raise a fresh invoice with the correct details and the next number in the invoice series.

What it is for

A credit note reverses an invoice, in whole or in part, after the invoice has been issued. It exists because an issued invoice cannot simply be deleted once it has entered two sets of books and, if you are tax-registered, declared tax.

Think of it as the correction mechanism for a system that deliberately does not allow rubbing things out.

When you need one

• The job was cancelled after you invoiced.
• You overcharged, or billed for something not delivered.
• You agreed a discount or a goodwill reduction after the fact.
• Goods were returned, or arrived damaged or faulty.
• Only part of the order was delivered.
• The invoice went to the wrong legal entity.
• The tax rate applied was wrong.

You do not need one for an invoice that was never sent, or for an undercharge — that is a second invoice, not a credit.

What goes on it

Essentially the same fields as an invoice, plus two:

• The words “credit note”, clearly, so it is not mistaken for a bill.
• Its own sequential number, from a credit-note sequence or your invoice sequence — consistently one or the other.
• A reference to the original invoice by number and date. Without this it is an orphan document.
• The reason for the credit, briefly.
• The amount, and the tax reversed, shown separately as on the invoice.

If you are VAT-registered in the UK, that list is not a style preference. Regulation 38 of the VAT Regulations sets it out: identifying number, date of issue, your name, address and VAT number, the customer’s name and address, a reference to the original invoice, a description of what is being credited, the price decrease excluding VAT, and the rate and amount of VAT credited in sterling.

Partial credits are normal

Crediting £400 of a £2,400 invoice is one credit note for £400 referencing the original. You do not cancel the whole thing and reissue. The client’s records then hold an invoice for £2,400, a credit for £400, and a balance of £2,000 — which is exactly what happened, and reconciles cleanly.

A worked example

You invoice a client £2,000 plus 20% VAT. Invoice 1043, total £2,400. Two weeks later they return a quarter of the order.

• You issue credit note CN-012, referencing invoice 1043.
• Net credited: £500. VAT credited: £100. Total: £600.
• Invoice 1043 stays exactly as it was. Nothing is edited.
• The client now owes £1,800, and both sets of books show why.

If they had already paid the full £2,400, the credit note still says £600 — and you separately refund £600. Two records, two events.

The tax effect

A credit note reverses the tax as well as the net. If you declared £820 of tax on an invoice you have now credited in full, that £820 comes back in the period the credit note is issued — not by amending the earlier return. Which period the adjustment lands in matters at year end, and it is the reason the date on a credit note is not cosmetic.

Tax names, rates and credit-note rules differ by country. The UK, Ireland, Australia, Canada, India and United States guides each cover their own version.

The 14-day rule in the UK

This one is widely got wrong, including by some large sites: in the UK a VAT credit note must be issued within 14 days, not 45. Since 1 September 2019 the clock runs from the date the refund payment is made to the customer, under the Regulation 38 rules.

Miss it and the adjustment is not simply late — HMRC treats it as an error to be corrected under the normal error-correction rules, which carry a four-year window. The practical advice is dull but correct: raise the credit note when the decision is made, not when someone gets round to it.

How it lands in the books

In double-entry terms a credit note is the mirror of the invoice that produced it. Using the example above:

• Debit sales / revenue £500 — you earned less than you first recorded.
• Debit VAT output tax £100 — you owe the tax authority less.
• Credit accounts receivable £600 — the customer owes you less.

The original invoice entry is untouched. That is the whole point: the audit trail shows an invoice, a credit, and the net position, rather than one figure that quietly changed.

Credit note versus refund

They are different events and either can happen without the other. A credit note adjusts what is owed. A refund moves money. Credit an unpaid invoice and nothing needs to move; credit a paid one and you also owe a refund. Keep the two records separate — the credit note documents the adjustment, the bank record documents the payment.

Credit note versus debit note

The difference is who raises it and which direction it points.

• A credit note is raised by the seller and reduces what the buyer owes.
• A debit note is raised by the buyer, asking the seller to reduce the bill or return money — typically after short delivery or damaged goods.

A debit note is a request, not an accounting entry in the seller’s books. It usually ends with the seller issuing a credit note, which is the document that actually adjusts the tax and the ledger. If you receive a debit note, nothing has changed in your records until you respond with a credit note or decline it.

What the customer does with it

From the buyer’s side a credit note is not cash. It reduces a balance. They can set it against the invoice it references, carry it against a future invoice from you, or ask for the money back if they have already paid.

Which of those happens is a commercial decision between you, and it is worth stating on the document: “to be offset against your next invoice” prevents a chase for payment you both know is not coming.

What not to do instead

Do not delete the invoice, do not edit it in place, and do not net the correction off the next invoice as a mystery negative line. The last one is common and creates an invoice whose total nobody can reconcile to anything. Editing an invoice after sending covers the alternatives properly.

Primary source: HMRC on accounting for VAT after prices are altered, which sets the 14-day period and the Regulation 38 contents list. Other countries set their own deadline — check the guide for yours.

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