Contra Payments: How to Offset Customer and Supplier Invoices

A contra payment is an agreed set-off between amounts that two businesses owe each other. The agreed amount reduces the customer and supplier balances by the same amount without passing through either business's bank account. Only the difference is paid or received in cash.

Suppose a customer is also a supplier. Your business has invoiced it for £1,200, while it has invoiced you for £800. If both parties agree to offset £800, the supplier invoice is settled in full, £800 is cleared from the customer account, and the customer still pays you £400. The two original invoices remain separately recorded, including for UK VAT purposes.

The set-off changes how the debts are settled, not the underlying transactions. It is therefore different from:

• a transfer between cash and bank accounts, sometimes described as a contra entry in bookkeeping;
• barter, where goods or services are provided in exchange for other goods or services rather than money;
• intercompany netting between entities in the same group; and
• payments made through Contra, the freelance services platform.

Keep both invoices instead of creating a contra invoice

A contra does not turn two supplies into one net transaction. Keep the sales invoice raised to the customer and the purchase invoice received from the supplier in their respective ledgers. Each document should retain its original value, date, VAT treatment and reference.

A contra invoice can be a misleading description. A contra is the settlement of existing receivable and payable balances. It is not a replacement invoice, and agreeing an offset is not a reason to cancel otherwise valid documents or issue new invoices for the net amount.

The distinction from a credit note is important. A credit note reduces or reverses an amount previously charged because the underlying supply or invoice needs correcting. A contra payment leaves the amounts charged for both supplies intact and changes only how the resulting debts are discharged. See the difference between a credit note and an invoice when deciding whether the source transaction itself needs correcting.

Recording only the cash remainder would understate the activity in both ledgers. In the £1,200 sales and £800 purchase example, entering only a £400 receipt would fail to show how the £800 supplier balance was settled. Keeping the invoices and recording the allocation separately preserves turnover, purchases, VAT records and the audit trail from each document to its eventual settlement.

Agree the set-off and leave a clear evidence trail

Confirm the contra with the other business before posting it. There is no single universal contra form for an ordinary trade settlement, but the record should make the agreed allocation reproducible. An email, letter or system-generated notice can do that if it identifies:

• both legal entities;
• the sales and purchase invoice numbers and original totals;
• the amount set off against each balance;
• the effective settlement date; and
• the amount that remains payable, and by whom.

This evidence should say that the specified debts have been discharged to the stated extent. A note that the parties have merely discussed a contra does not establish that either ledger balance has been settled. The effective date also matters when the accounting period or VAT treatment depends on when payment occurred.

A remittance advice can show which invoices the contra covers and how the remaining payment was calculated. The same allocation principles described in what a remittance advice records apply whether the notice accompanies a bank payment or documents a partly non-cash settlement.

Agreement evidence is a bookkeeping control, not proof of a universal right to set off any two amounts. Where a debt is disputed, a contract limits set-off, or either party is insolvent, establish the legal position before treating the balance as discharged.

Contra payment accounting entries with a worked allocation

The accounting invariant is simple: the same agreed amount must reduce both the receivable and the payable. Any difference stays open on one ledger until it is paid through the real bank account.

Take the earlier example. Your business has a £1,200 customer balance and an £800 supplier balance with the same company. The parties agree an £800 contra, after which the company pays your business £400.

Stage	Customer ledger	Supplier ledger	Clearing account	Real bank
Before settlement	£1,200 due to you	£800 due from you	£0	£0 movement
Post the contra	Reduce by £800	Reduce by £800	£800 in and £800 out	£0 movement
After the contra	£400 due to you	£0	£0	£0 movement
Receive the balance	Reduce by £400	£0	£0	£400 receipt
After settlement	£0	£0	£0	£400 receipt

Where software uses a dedicated contra or clearing account, the illustrative entries for the equal offset are:

Entry	Debit	Credit
Clear part of the customer balance	Contra clearing £800	Trade receivables £800
Clear the supplier balance	Trade payables £800	Contra clearing £800

The first entry records £800 of settlement against the customer account. The second records the identical amount against the supplier account. Together they return the clearing account to zero. The later £400 receipt is recorded in the usual way by debiting the real bank account and crediting trade receivables.

The clearing account is an internal accounting mechanism, not a physical bank account that the business needs to open. Its job is to connect the two ledger allocations where no money moved through the bank.

Accounting packages implement this result differently. Some route only the equal £800 offset through a clearing account. Others post the full invoice balances through a contra or control account, then use the actual £400 bank transaction to clear the difference. Follow the documented method for the package in use and check the same outcome: £800 removed from each opposing balance, £400 matched to the remaining receivable, and no unexplained amount left in clearing.

The bank statement shows only £400. During payment reconciliation, match that receipt to the £400 still open after the contra, not to the full £1,200 sales invoice. The £800 difference is supported by the agreed non-cash allocation, not by a missing bank transaction.

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UK VAT treatment of a contra payment

Under HMRC's guidance on VAT set-offs, when both businesses are VAT-registered, each must account for VAT on each separate supply even if no money changes hands or only the net balance is paid after set-off.

Contra payment VAT is therefore not calculated only on the amount visible in the bank. In the worked example, the £400 receipt is the residual settlement, not the value of the sales supply. The sales invoice and purchase invoice retain their separate values and VAT records.

The settlement date and the VAT tax point are not automatically the same. If a VAT invoice has already established the tax point, posting the later contra does not create another tax point for that supply. Where no tax point has already arisen, HMRC's set-off manual explains that an accounting entry can amount to payment when it actually discharges the mutual debt. An entry that merely acknowledges an outstanding amount does not do so.

Businesses using the Cash Accounting Scheme need to apply the scheme's payment timing and allocation rules rather than the normal invoice-based timing. A contra counts as payment to the extent that the accounting entry actually discharges the mutual debts. VAT Notice 731 bases VAT under the scheme on payments received and made, and contains specific rules for partial payments and payments covering more than one invoice. Record the portion discharged by the contra and the remaining cash payment separately, then check the treatment where multiple invoices, mixed VAT rates or partial allocations are involved.

An offset of existing monetary debts should not automatically be treated as barter. Barter concerns payment with goods or services and has its own timing rules. A contra between invoice balances instead turns on whether, and when, the agreed book entry discharged those debts.