HMRC has recently published Revenue & Customs Brief 12/2020 stating that receipt of payments linked to early termination of a contract should now be treated as taxable. To date, receipt of such payments has been treated as compensation by businesses and therefore outside the scope of VAT, a practice which HMRC have accepted as correct for a number of years. This change will have a significant impact on all businesses which regularly set minimum contractual terms and therefore are in receipt of termination payments from customers wishing to exit contracts and /or leases earlier than planned.
The R&C Brief references ‘recent’ CJEU cases, Meo and Vodafone Portugal, both of which look closely at the VAT treatment of early termination payments. In Vodafone Portugal, the CJEU stated that payments made by customers to enable them to terminate their contracts earlier than the minimum term was in fact consideration for a supply of services, resulting in VAT being due. The judgement found that any amount payable in the event of early termination of the contract was intrinsically linked to the overall price the customer agreed to pay for its phone contract with Vodafone; treatment of the termination fee as further consideration for that supply was therefore a reflection of the economic reality of the transaction.
Whilst these changes are clearly relevant to phone contracts and other similar, limited term agreements, they may also have a significant impact on breaks to property leases, particularly where the existing lease is exempt and/or there is no break clause built in to the contract. HMRC’s existing guidance around lease variation payments confirms that these are consideration for a supply, with payments received being exempt subject to an option to tax. As yet VAT Notice 742 (Land and Property) has not been amended to reflect any change to the VAT treatment of these payments in line with this new guidance. However, as noted below, HMRC’s Supply and Consideration Manual VATSC05920 considers lease termination payments to also be consideration for a supply and therefore subject to VAT.
In line with the rulings derived from the above judgements HMRC has updated all relevant VAT Manuals (deleting the previous versions) to clarify that termination payments, early upgrade fees, liquidated damages and breaches of contract will now be treated as further consideration for a taxable supply. HMRC guidance states “it is only where there is no direct link between a payment and a supply of goods or services that it may be outside the scope of VAT.” Guidance note VATSC05920 confirms that VAT is due, even if a separate cancellation agreement is drafted out with the terms of the original contract.
Finally, HMRC have stated that businesses that have failed to account for VAT on payments of this nature should take action to correct the error, via submission of an error correction. The R&C brief does not specify when this change in VAT treatment should be applied from, but the implication is that corrections should cover the past 4 years, unless the business has received a specific ruling to the contrary from HMRC.
Other important VAT updates:
Call for Evidence
The government is particularly interested in responses direct from businesses, especially the financial services industry whether they currently utilise the VAT grouping provisions or not, as well as related representative bodies.
A significant amount of information is being requested via the document; however businesses which have overseas branches or whose head office is located in another EU state, may be particularly interested in taking part in the consultation or any amendments to the current UK rules which may result from its outcome, whether already part of a VAT group or giving consideration to creating one.
Trading with the EU from January 2021
HMRC has this week sent letters to VAT-registered businesses in the UK that trade with the EU and the rest of the world, highlighting what actions they need to take to be able to continue trading with the EU from 1 January 2021. This follows on from earlier step by step guidance published in July regarding how to import or export goods from the UK from 1 January.
Businesses which are concerned about how to prepare for these changes should get in touch with our VAT and Indirect Tax specialists for further advice.
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