Credit Note vs Invoice: What's the Difference and When to Use Each

If you run a business in the UK, you'll encounter situations where a standard invoice doesn't quite fit — a customer returns a product, you accidentally overcharge someone, or there's a billing error that needs correcting. That's where credit notes come in. Understanding the difference between a credit note and an invoice is essential for keeping your accounts accurate, staying compliant with HMRC, and maintaining professional relationships with your clients.

What Is an Invoice?

An invoice is a document issued by a seller to a buyer requesting payment for goods or services provided. It's essentially a formal demand for money. Every invoice should include your business details, the customer's details, a unique invoice number, a description of what was supplied, the amount due, and payment terms.

Invoices create an accounts receivable entry in your books — they represent money owed to you. In the UK, invoices are also the primary document HMRC uses to verify your income for tax purposes, and VAT-registered businesses must issue VAT invoices that meet specific HMRC requirements.

What Is a Credit Note?

A credit note (sometimes called a credit memo) is a document issued by a seller to a buyer that reduces the amount owed on a previous invoice. Think of it as the opposite of an invoice — where an invoice increases the amount a customer owes you, a credit note decreases it.

Credit notes are not refunds in themselves. They are accounting documents that adjust your records. The actual refund — whether it's a bank transfer back to the customer or a reduction applied to their next invoice — is a separate transaction. The credit note simply provides the paper trail.

Key Differences Between a Credit Note and an Invoice

When Should You Issue a Credit Note?

There are several common situations where issuing a credit note is the correct course of action:

• Goods returned: A customer returns a product that was delivered in good faith. The original invoice was correct at the time, but the return means the customer no longer owes the full amount.
• Overcharging or pricing errors: You accidentally invoiced for a higher amount than agreed, charged the wrong unit price, or applied an incorrect quantity. A credit note corrects the difference.
• Defective or damaged goods: The customer received goods that were faulty or damaged during delivery. Rather than issuing a completely new invoice, you issue a credit note to adjust the original.
• Agreed discounts applied after invoicing: You offered a retrospective discount (such as a volume discount that kicks in once a threshold is met) that wasn't reflected on the original invoice.
• Cancellation of services: A customer cancels a service partway through a billing period and is entitled to a partial adjustment.
• Duplicate invoices: You accidentally sent two invoices for the same work. Rather than deleting an invoice (which breaks your audit trail), you issue a credit note against the duplicate.

What Should a Credit Note Include?

A properly formatted credit note should contain the following information:

• The words “Credit Note” clearly displayed
• A unique credit note number (separate from your invoice numbering)
• The date of issue
• Your business name, address, and contact details
• The customer's name and address
• A reference to the original invoice number and date
• A description of the reason for the credit
• The amount being credited (with and without VAT, if applicable)
• The VAT amount being adjusted (if VAT-registered)
• Your VAT registration number (if applicable)

Credit Notes and VAT in the UK

If you're VAT-registered, credit notes have direct implications for your VAT returns. When you issue a credit note, you are effectively reducing the VAT you owe to HMRC on that transaction. The customer, in turn, must reduce the VAT they've reclaimed on their purchase.

HMRC requires that VAT credit notes include all the information listed above, plus your VAT registration number and the VAT rate applied. If the credit note relates to a supply where VAT was charged at the standard rate of 20%, the credit note must also show the VAT adjustment at 20%.

Under Making Tax Digital (MTD), your digital records must include credit notes alongside invoices. Your accounting software should automatically adjust your VAT return when you record a credit note, but it's worth checking that these adjustments are flowing through correctly — especially around the end of a VAT quarter.

Important timing rule: You should issue the credit note in the same VAT period as the event that triggered it, if possible. If you issue a credit note in a later period, the VAT adjustment applies to the period in which the credit note is issued, not the period of the original invoice.

UK Legal Requirements for Credit Notes

While UK law does not prescribe a single rigid format for credit notes, HMRC expects them to meet certain standards:

1. Keep records for 6 years: Just like invoices, you must retain credit notes for a minimum of 6 years for HMRC compliance.
2. Never delete an invoice: If an invoice is wrong, do not delete it or alter it. Instead, issue a credit note against it. This maintains your audit trail and keeps your records defensible.
3. Use a separate numbering sequence: Credit notes should have their own sequential numbering system (e.g., CN-001, CN-002) rather than sharing the invoice number sequence.
4. Reference the original invoice: Always link the credit note back to the specific invoice it relates to. This makes it easy for you, your customer, and HMRC to trace the paper trail.

Can You Just Issue a New Invoice Instead?

A common question is whether you can simply cancel the original invoice and issue a new, corrected one. The answer is: no, you should not. Deleting or voiding invoices breaks the sequential numbering required by good accounting practice and can raise red flags with HMRC. The correct approach is always to issue a credit note against the original invoice, and then issue a new invoice if necessary.

For example, if you invoiced a client £1,200 but the correct amount was £1,000, you would issue a credit note for £200 against the original invoice. You would not delete the £1,200 invoice and create a new £1,000 one.

Common Mistakes to Avoid

• Issuing a credit note without referencing the original invoice: Always include the original invoice number. Without it, the credit note is much harder to reconcile and could be queried by HMRC.
• Using credit notes to mask bad debts: A credit note should only be issued when there's a genuine reason to reduce the amount owed. If a customer simply hasn't paid, that's a bad debt — not a credit note situation. Bad debts have their own accounting and VAT treatment.
• Forgetting to adjust VAT: If the original invoice included VAT, the credit note must also show the VAT adjustment. Failing to do so means your VAT return will be incorrect.
• Issuing a credit note for the wrong amount: Double-check the figures. A credit note with the wrong amount creates more confusion and may require yet another correction.
• Not communicating with the customer: Always send the credit note to your customer and explain why it's been issued. This avoids confusion, especially if they're expecting a refund or a balance adjustment.

Credit Note vs Refund: What's the Difference?

People often use “credit note” and “refund” interchangeably, but they're not the same thing. A credit note is an accounting document that adjusts the balance between you and your customer. A refund is the actual transfer of money back to the customer.

You might issue a credit note and then refund the money to the customer's bank account. Alternatively, you might issue a credit note and apply the credit to the customer's next invoice, so they pay less next time. The credit note records the adjustment; the refund (or offset) is how that adjustment is settled.

How to Create a Credit Note: Step by Step

1. Identify the original invoice that needs correcting. Note its number, date, and the amount to be credited.
2. Assign a credit note number from your separate credit note sequence (e.g., CN-001).
3. State the reason clearly — “goods returned in full,” “pricing error on Invoice #1042,” or “service cancellation for March 2026.”
4. Calculate the credited amount including the correct VAT adjustment if applicable.
5. Send the credit note to the customer and file your copy.
6. Record it in your accounting system so it adjusts your accounts receivable and VAT records.
7. Process the refund or offset — transfer money back or apply the credit to the customer's next invoice.

Keep Your Invoicing Clean From the Start

The best way to minimise the need for credit notes is to get your invoices right first time. Double-check quantities, pricing, and customer details before sending. Use clear descriptions so there's no ambiguity about what was supplied. And always confirm the agreed price with your customer before invoicing.

That said, credit notes are a normal part of business. Every business issues them from time to time. The key is to handle them properly — with correct documentation, clear communication, and accurate VAT treatment.