HMRC has published Revenue and Customs Brief 2 (2022) to introduce a revised policy on the VAT treatment of early termination fees and compensation payments with effect from 1 April 2022. It replaces guidance in Revenue and Customs Brief 12 (2020) that was suspended in January 2021 following representations from industry.
Prior to Revenue and Customs Brief 12 (2020), HMRC’s guidance stated that when customers are charged to withdraw from agreements to receive goods or services, these charges were not generally for a supply and were outside the scope of VAT.
However, judgements from the Court of Justice of the European Union in Meo (C-295/17) and Vodafone Portugal (C-43/19) found that some of these charges are additional consideration for the supply of goods or services.
HMRC’s policy is now that most early termination fees and some cancellation fees are therefore liable for VAT if the goods or services for which the fees have been paid are liable for VAT even if they are described as compensation or damages.
This means that fees charged when customers terminate a contract early will be regarded as further consideration for the contracted supply. For example, where a customer is charged a fee for exiting a mobile phone contract early, or if they terminate a car hire contract early, the fee will be liable for VAT, according to HMRC.
However, HMRC’s revised policy will result in fewer payments being regarded as within the scope of VAT than in the policy set out in 2020, as that policy stated that most early termination and cancellation fees are liable for VAT.
The new guidance can be found in HMRC’s VAT Supply and Consideration Manual at VATSC05910, VATSC05920 and VATSC05930.
The former guidance at VATSC06710, VATSC06720 and VATSC06730 has been deleted. The suspended September 2021 version of the guidance included at VATSC05910, VATSC05920 and VATSC05930 is also withdrawn. If it is necessary to access earlier versions, these can be found via the timeline function on the National Archives website.
All businesses must adopt the revised treatment no later than 1 April 2022. This includes any taxable person that has had a specific ruling from HMRC stating that such fees are outside the scope of VAT.
Businesses that adopted the revised treatment for payments that are further consideration for supplies should continue to treat these supplies in accordance with the revised policy.
Any business that adopted the treatment outlined in Revenue and Customs Brief 12 (2020), published in September 2020, and accounted for VAT on transactions that under the revised policy outlined in Revenue and Customs Brief 2 (2022) are considered to be outside the scope of VAT, may correct this in the normal way – see HMRC’s guidance on error correction.
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