VAT ON EARLY TERMINATION FEES AND COMPENSATION PAYMENTS
On 2 September 2020 HMRC announced that the VAT treatment of cancellation and early termination fees had changed. In the past these payments have usually been regarded as compensation and so outside the scope of VAT. However, following two EU cases on cancellation and early termination fees involving mobile phone contracts it was decided that these payments were further payments due under the contract and so had the same VAT status as other payments for goods and services made under the same contract. The changes to HMRC’s policy were set out in Revenue and Customs Brief 12 (2020).
There were two controversial aspects to the changes:
- It was clear that VAT would apply to a wide range of payments that had previously been regarded as compensation such as some payments for breach of contract and some payments for dilapidations.
- The change was retrospective; HMRC invited businesses to correct their VAT returns covering the previous four years for underdeclared VAT on income now regarded as taxable.
There were widespread objections from the tax profession and the business sectors severely affected by the change and in January 2021 HMRC suspended the application of Brief 12 (2020) so that representations from interested parties could be considered.
HMRC has now updated the guidance in its internal manuals and a new Revenue and Customs Brief 2 (2022) has been issued.
The changes will now take effect from 1 April 2022. Early termination charges are now assumed to be further payments in consideration of the supply and so liable to VAT in the same way as the main supply. Most charges for cancellation of a contract will also be brought within the scope of VAT.
One of the main changes from the original Brief is that payments for dilapidations will, in most circumstances, continue to be regarded as compensation and so outside the scope of VAT.
Further details of the circumstances in which these types of charge will be within the scope of VAT are set out in HMRC’s manuals at VATSC05910, VATSC05920, and VATSC05930.
All payments that are now liable to VAT as set out in HMRC’s guidance must be subject to VAT on or after 1 April 2022. This includes payments on which a ruling had previously been obtained from HMRC.
Businesses that have always treated these payments as vatable, or who adopted this policy from September 2020, must not adjust their returns to treat the payments as outside the scope for periods before 1 April 2022.
However, businesses that have adjusted previous returns to account for VAT on payments that are outside the scope according to the revised guidance, or have been accounting for VAT on outside the scope payments may make an adjustment.