What is the issue and why has HMRC’s policy been revised?
HMRC previously viewed that charges made to customers to withdraw from agreements to receive goods or services were not generally made for a supply, so were outside the scope of VAT.
However, given the Court of Justice of the European Union (CJEU) judgments in Meo (C-295/17) and Vodafone Portugal (C-43/19), some of these charges are clearly additional consideration for the goods or services provided. This means that most early termination fees and some cancellation fees are therefore subject to VAT if the underlying goods or services for which the fees have been paid are VATable, regardless of whether they are called compensation or damages.
As a result of various representations from industry, HMRC’s previous guidance regarding the VAT treatment of early termination fees and compensation type payments set out in RCB 12 (2020) as published in September 2020 was subsequently suspended in January 2021. Since this time, businesses have been waiting for HMRC to provide updated guidance to clarify the VAT accounting treatment. HMRC has now completed their review in light of the representations and has published its revised policy in RCB 2 (2022), which will become effective from 1 April 2022.
What is HMRC’s revised position from 1 April 2022?
From 1 April 2022, HMRC’s policy on early termination fees, compensation and similar payments (e.g. liquidated damages) will change. HMRC’s guidance manuals have also been changed to outline exactly when HMRC considers such payments are made in relation to a supply and potentially subject to VAT.
Under the revised policy, fees charged to customers for early termination of a contract (compensation, liquidated damages or similar) will represent further consideration for the main contracted supply. HMRC states the example of a customer charged a fee for exiting a mobile phone or car hire contract early, which will be subject to VAT.
Businesses must therefore account for VAT on these fees if the supply is taxable at the same rate of VAT as the supply. This will apply regardless of whether the original contract allows for such a termination, or whether a separate agreement is reached. At VATSC05910, HMRC says “How that fee is described does not affect whether there is a supply for VAT. What matters is whether something is done and if there is a direct link between what is done and the payment received, and reciprocity between the supplier and the customer.”
If an early termination fee is paid for terminating a contract which covers more than one supply, then if it is unclear to which supply the termination payment relates, a reasonable apportionment will be needed.
HMRC confirm that this will not impact the treatment of full or part payments made on account for a taxable supply (i.e. retained payments for unfulfilled supplies) which will remain subject to VAT as set out in RCB 13 (2018). The VAT treatment of deposits and retained payments by businesses making supplies subject to the Tour Operators’ Margin Scheme is set out in RCB 9 (2010).
Where can I find HMRC’s updated guidance?
HMRC’s previous guidance at VATSC06710, 06720 and 06730 has now been withdrawn, along with the suspended September 2021 version of guidance at VATSC05910, VATSC05920 and VATSC05930.
The new guidance is located at VATSC05910, VATSC05920 and VATSC05930 (see links below).
Who will this affect?
This will impact persons or businesses across all sectors who make charges to customers to withdraw from agreements to supply goods or services, as well as the customers themselves. Both parties will need to revisit any existing and new contracts to ensure that these properly reflect the revised VAT accounting position (see below).
Which payments will remain outside the scope of VAT?
The revised policy will mean that from 1 April 2022 onwards, more payments will fall outside of the scope of VAT compared to the previous policy outlined in 2020.
For example, HMRC’s guidance VATSC05910 refers to dilapidation payments which occur in the land and property sector. HMRC acknowledge that these types of payments vary in how they are provided for but largely exist to ensure landlords are not out of pocket where buildings are not returned in the agreed condition at the end of a lease. HMRC states that it will continue to regard these as normally outside the scope of VAT (i.e. not to treat dilapidation payments as further consideration for the supply of a lease). However, HMRC may take an alternative view where there is evidence of value shifting from rent to dilapidation payments in order to avoid accounting for VAT.
Similarly, if additional fees are charged for parking, these will represent further consideration for the supply of parking if the fees are for the additional use of the parking space. HMRC’s view is that if a fine is substantial and punitive and is designed to deter a breach of the terms and conditions of parking, then it will be outside the scope of VAT because the reciprocity needed to link it to the supply is insufficient to regard it as additional consideration. But, if the fees are an additional charge for occupying a space, this would be a VATable supply. The level of the additional fees in comparison to the standard parking fee may indicate which category a particular fine would fall within.
In cases where a supplier breaches the terms of a contract, rather than the customer, they may reduce the price charged for the supply, as what is being supplied has been altered. But, if there is no price adjustment, but the supplier agrees to pay liquidated damages to compensate the customer for the actual loss suffered as a result of the breach, the payment will be outside the scope of VAT. This is because the payment may bear little relation to what was provided under the contract and in such case, the payment will not be sufficiently linked to the supply to be treated as reduced consideration.
What should I do now?
Affected businesses – including any which have previously received specific rulings from HMRC stating that such fees are outside the scope of VAT – will need to apply the revised VAT treatment no later than 1 April 2022 onwards.
Any existing contracts should also be revisited and changes made to ensure VAT can be charged going forward where needed, and discussions held with the relevant counterparty. For example, if contracts have been drafted on a ‘VAT inclusive’ basis, this could bring difficulty if compensation type payments arise in respect of which VAT will now be chargeable. If contracts are silent on VAT, these should at the very least, be urgently amended to contain a general VAT charging clause (to include the wording ‘plus VAT where applicable’) so that suppliers can recover any VAT payments from customers.
Where VAT needs to be charged on compensation payments, associated invoices will need to be issued, so there will be an additional administrative/compliance aspect for both parties to address. Cashflow issues may also arise where the payments are significant, so a commercial discussion will be needed on all of this.
What should I do if I adopted the treatment outlined in the previous RCB 12 (2020)?
If you applied the revised treatment for payments that are further consideration for supplies, you should continue to treat these supplies in accordance with HMRC’s revised policy going forward.
If you adopted the VAT treatment outlined in HMRC’s guidance published in September 2020 (i.e. if you accounted for VAT on transactions which under the latest guidance are outside the scope of VAT – e.g. dilapidation payments as above), then you may correct this under the normal error correction procedures.
Next steps
If you would like us to advise you further on the impact of these changes upon your business or if you have any questions regarding your own situation, please contact us or your usual A&M VAT adviser.
Next steps
If you would like us to advise you further on the impact of these changes upon your business or if you have any questions regarding your own situation, please contact us or your usual A&M VAT adviser.
Useful HMRC Links
Revenue and Customs Brief 2 (2022): VAT early termination fees and compensation payments – GOV.UK (www.gov.uk)
Revenue and Customs Brief 12 (2020): VAT early termination fees and compensation payments – GOV.UK (www.gov.uk)
VATSC05910 – VAT Supply and Consideration – HMRC internal manual – GOV.UK (www.gov.uk)
VATSC05920 – VAT Supply and Consideration – HMRC internal manual – GOV.UK (www.gov.uk)
VATSC05930 – VAT Supply and Consideration – HMRC internal manual – GOV.UK (www.gov.uk)
Revenue and Customs Brief 13 (2018): change to the VAT treatment of retained payments and deposits – GOV.UK (www.gov.uk)
Revenue and Customs Brief 9 (2019): VAT Tour Operators Margin Scheme and retained payments and deposits – GOV.UK (www.gov.uk)