HMRC announces changes to VAT on early contract termination

Background

In September 2020, HMRC announced an update to its guidance on the VAT treatment of early termination fees compensation payments and liquidation damages.

Historically the HMRC guidance was that contractual compensation payments that were designed to compensate a party in the event of an early termination of a contract fell outside the scope of VAT. The original guidance acknowledged the difficulties in determining whether a payment is compensatory or forms part of the consideration for a supply.

Following the recent decisions of the CJEU in Vodafone Portugal (Case C-43/19) and the decision in Meo (C-295/17) HMRC has now updated its VAT manual and published a brief that states payments are no longer VAT exempt and will be treated as consideration for taxable supply.

Key updates:

  1. Early termination payments will be treated as consideration for the supply of goods or services which the customer has contracted for.
  2. Early upgrade fees will be treated in the same way and be subject to VAT.
  3. Liquidated damages are now treated as consideration for a supply. In the updated guidance HMRC acknowledges that although such payments are aimed at compensating, they arise from events from events contemplated under the contract therefore are consideration for what is provided under the contract.
  4. Liquidated damages payments for early termination under a lease agreement such as vehicle finance lease are now treated as taxable.
  5. Payments for breaches of contract which result in automatic termination of the contract or entitles the supplier to terminate the contract are now treated by HMRC as further consideration for a supply.

You can find more detailed information on these updates in the VAT manuals

VATSC05910VATSC05920 and VATSC05930.

Who this affects?

These updates are applicable to businesses that have contracts with customers for minimum commitment periods and customers are subject to termination fees for withdrawal.

What next?

Businesses need to consider if any VAT that should have been charged can still be recovered from customers. They should also consider if any payments which have been treated as compensation outside the scope of VAT can now recover VAT that should have been treated as included in the initial payment.

GM&Co suggest seeking specialist advice and one of our taxation specialists would be available to answer any questions you may have please contact us on 0121 550 8509 or email info@godfreymansell.co.uk.