UK & Europe
Revenue and Customs Brief 12 (2020): VAT early termination fees and compensation payments.
This brief gives an update on the VAT treatment of compensation and similar payments following recent judgments of the Court of Justice of the European Union (CJEU).
In September, HMRC published a policy paper announcing a change in the VAT treatment of compensation payments (Revenue and Customs Brief 12 (2020)). Agreements that allow for early termination generally provide for payment of compensation in the event of such termination. These amounts may be expressed as compensation for loss of earnings and/or liquidated damages.
HMRC's previous guidance said they would treat these payments as outside the scope of VAT because they were not paid under the contract but outside it. Following recent decisions of the Court of Justice in the European Union, HMRC say that they now consider that these amounts are paid as a result of events envisaged under the contract.
Accordingly, HMRC have revised their guidance so that it now says that most payments for early termination or cancellation of a contract will be treated as consideration for a supply and therefore liable for VAT. HMRC’s guidance makes it clear that this principle applies regardless of whether the early termination payment is provided for in the original agreement or separately negotiated at a later date.
This change of view follows the recent decisions of the Court of Justice in the European Union (CJEU) in MEO (Case C-295/17) and Vodafone Portugal (Case C-43/19).
In MEO – C-295/17, the Court held that a requirement for the customer to pay the remaining fees on early termination of a telecom contract means the supplier is receiving further consideration for the original supply – even if the customer is no longer making use of that supply. In the more recent case of Vodafone Portugal – C-43/19 the Court said the same the principle applied even if the amount payable is not equal to the amount that would have been due had the contract been fulfilled.
Controversially, HMRC has changed its policy retrospectively by saying that taxpayers who have previously failed to account for VAT in accordance with its new policy should correct the error.
In the property context, this could have significant implications. The majority of compensation or liquidated damages payments in property contracts (e.g. on an early termination or failure to complete) or which are separately negotiated are now likely to be treated as consideration for a supply of goods or services for VAT purposes. This could mean that these payments are now subject to VAT depending on which party is making the supply and whether they have opted to tax their interest in the property.
It is currently unknown whether HMRC will issue further guidance on the treatment of compensation payments for VAT purposes.
Given the uncertainties around what is affected by the change of view and the reference to the changes applying retrospectively, it would be sensible to ensure that contracts contain clear language to allow the VAT to be adjusted if the VAT position changes.
Specialist tax advice should normally be sought from the tax team in relation to any tax issues that may arise in the course of your work. Please contact Ray Smith, David Blumenthal, Malcolm Frost or any other member of the tax team for further assistance.