VAT and early termination fees

VAT is a tax on the supply of goods and services. Following a recent court judgement, HM Revenue and Customs (HMRC) has issued some important guidance as it has changed its position on VAT and termination fees. HMRC advises that anyone who charges their customers to withdraw from agreements to supply goods or services may be affected. Historically, HMRC took the view that payments described as 'compensation' were typically outside the scope of VAT.

If one party allows another to end a contract for the supply of services early, in the past, this has not necessarily been a transaction which has attracted VAT. The new guidance suggests that when customers are charged to withdraw from agreements to receive goods or services, this will now 'generally' be a taxable supply and is thus liable for payment. Importantly, this applies even if the payment is described as 'compensation' or 'damages'. 

Examples of areas which might be affected by this change of policy are:

  • contract termination
  • liquidated agreements
  • lease agreements for movable goods
  • breach of contract

This change of policy could be very wide ranging because HMRC gives one very common example in relation to mobile phones. Charges made when exiting one contract and entering into another to upgrade a mobile telephone package or handset will now be liable to VAT.

Note that HMRC is not completely clear in its guidance because its own website states that compensation or early termination fees in a contract will only 'generally' be liable for VAT. Thus, any person or business who might be affected by this change should take professional advice because HMRC is expecting any taxable person that has failed to account to HMRC for VAT on fees to correct the error. This would mean putting in a corrective account and paying any additional VAT that may be due.

Any taxable person that has had a specific ruling from HMRC saying that such fees are outside the scope of VAT should account for VAT on such fees received after the issue of the HMRC guidance, published on 2 September 2020.

To discuss this or any other commercial matter, contact us.

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