Sometimes an invoice goes out and the details of the transaction change. Maybe a customer returns part of their order or you spot a pricing error. Maybe the scope of the project shifts after billing. You can’t just delete the invoice or pretend it didn’t happen, so how do you correct it in a way that’s in line with accounting standards and keeps your records in order? This is where credit notes are useful. In this guide, we’ll discuss how credit notes work, when to use them, and why they matter for tax compliance.

What’s in this article?

• What is a credit note?
  
• How does a credit note work?
  
• When should businesses issue a credit note?
  
• Are credit notes required for tax compliance?
  

What is a credit note?

A credit note—sometimes called a credit memo—is a document a business sends to a customer to reduce or cancel part of a previously issued invoice. It’s essentially a way to indicate to a client that they don’t owe the full balance they were billed.

Like invoices, credit notes are legally binding documents. They reference the original invoice and explain what’s being credited and why, whether it’s a refund, a return, or a pricing error. The original invoice stays untouched on your books, but the credit note offsets it and creates a clear audit trail.

Imagine you issued an invoice for $1,000 but then realized you overcharged by $100. Instead of editing or deleting the original invoice (which most accounting systems don’t allow once it’s finalized), you issue a credit note for $100. That credit is either refunded to the customer or applied to a future balance.

How does a credit note work?

A credit note is created as a separate document that references the original invoice. It records that money is owed to the customer or no longer owed by them, but the actual refund, if there is one, is a separate action. The credit note provides the proof, rather than the transaction.

On your books, the credit note reduces recognized revenue and accounts receivable, as you’re no longer expecting that part of the payment. On the customer’s books, a credit note reduces their recorded expense or accounts payable.

Visually, credit notes look a lot like invoices, with a few distinctions. Credit notes include:

• A unique credit note number (different from your invoice sequence)

• The date issued

• The original invoice number

• Your business’s name, address, and contact details

• Your customer’s name and address

• A clear label (e.g., Credit Note, Credit Memo)

• The reason for the credit (e.g., “Returned goods — damaged on arrival”)

• The amount being credited (shown as a negative figure or in parentheses)

• Any associated taxes being reversed or adjusted

• A signature or authorization, if required

By issuing a separate document instead of changing an invoice after the fact, you keep your financial records consistent, comply with tax rules and accounting standards, and provide clear documentation for internal reviews, audits, or disputes.

If you’re managing dozens or hundreds of invoices, consider introducing automation into your workflow. For example, Stripe Invoicing allows you to generate a credit note directly from the original invoice. The system adjusts the customer’s balance or issues a refund if the invoice has already been paid.

When should businesses issue a credit note?

A credit note should be issued when a business needs to correct an invoice in the customer’s favor. Below are the most common scenarios where a credit note would be used.

Product returns

If a customer returns goods after they’ve been invoiced, you should issue a credit note for the value of those items. For example, if 10 units were sold and 2 come back, the credit note covers the cost of the 2 units returned. This formally removes that portion from the original sale and adjusts the customer’s balance.

Damaged or faulty items

If products arrive broken or don’t function as promised and you agree to refund or not to charge the customer for those items, you’ll issue a credit note. The note shows the customer no longer owes that part of the invoice.

Canceled orders

If an order is canceled after an invoice has gone out, a credit note accounts for the cancellation. If the entire order is canceled, the credit note cancels the full invoice. If only part is canceled, the credit note reduces the amount due accordingly.

Overbilling or invoicing errors

Mistakes happen: maybe the wrong quantity was billed, a discount wasn’t applied, or a duplicate charge slipped in. When an error happens, issue a credit note to correct it.

Partial delivery or incomplete services

If you bill for more than what’s delivered—for example, you bill for 50 units but only 45 ship—issue a credit note for the difference so you recognize revenue for only what was actually provided.

Post-invoice adjustments or agreed discounts

Even if the invoice was correct when it was sent, certain details might have changed. If you and the customer agree to a discount after the fact as a goodwill gesture, to resolve a dispute, or to reflect a change in scope, issue a credit note to formally document the reduced amount.

Are credit notes required for tax compliance?

Credit notes are often required for tax compliance. If you reduce or cancel an invoice that includes tax after it’s been issued, the tax authorities will expect to see a credit note that documents the adjustment. This ensures your filings reflect what actually happened in your business, not just what you originally billed. Once a credit note is issued, it changes what you report to the government.

• The credit note typically reduces the total taxable sales for the return period in which it was issued.

• Credit notes might need to be declared in specific forms or return schedules, depending on the timing and nature of the adjustment.

The credit note must be issued during the proper period and referenced correctly. Otherwise, even if the refund or return was legitimate, you could end up with mismatched records—or worse, trigger an audit.

If you issue a refund without a credit note, the tax office could treat the original invoice as valid in full. If you try to deduct that refunded amount from your tax return, you might be asked to prove it with the corresponding credit note.

Regional enforcement

The expectations around credit notes vary slightly by region, but the underlying principles are the same:

• In regions with value-added tax (VAT) or goods and services tax (GST)—such as the European Union and New Zealand, respectively—credit notes are usually mandatory for reducing tax liability for returned goods, canceled services, or pricing corrections. You cannot amend the invoice or omit the revenue from your return without one.

• In regions with different tax systems, credit notes are often not explicitly required but are still considered standard evidence to support revenue adjustments and are important for audit defense.

Some jurisdictions make explicit how long businesses have to issue credit notes. For example, companies in the United Kingdom must issue VAT credit notes within 45 days of the change.

Recordkeeping requirements

As with invoices, credit notes must be stored and retained for tax and audit purposes. In many countries, they must often be kept for 5–10 years.

Any time you reduce an invoice after it’s been issued—whether due to a return, an error, a partial delivery, or a post-invoice discount—a credit note formalizes that change. It keeps your records unified, your customers informed, and your tax filings accurate.