Reached a Settlement in the last 4 years? Beware of the VAT!
HMRC has historically always taken the view that payments described as “compensation” or “damages” and paid by a customer for alleged losses attributable to a breach of contract, early termination event or pursuant to a liquidated damages clause, were normally outside the scope of VAT instead viewing these types of payments to a supplier as payments to compensate for loss of future earnings flowing from termination rather than being directly linked to consideration paid for a relevant supply.
However, on 2 September 2020, HMRC published Revenue & Customs Brief 12 (2020). This brief updates taxpayers on the UK VAT treatment of early termination fees and compensation payments following recent judgments of the Court of Justice of the European Union (CJEU) and HMRC's changes to its guidance.
Under a significant change, HMRC will now treat most compensation and similar payments made by customers arising out of early termination or cancellation as generally liable for VAT on the basis that the payment made by the defaulting party has a direct link with a relevant supply and therefore should be seen as further consideration for the original supply by the recipient supplier. The fact that the customer is no longer making use of that supply is irrelevant.
This treatment will apply in cases where an original contract allows for such a termination, as well as when a separate agreement has been reached. This change will therefore affect payments for breach of contract, liquidated damages, cancellation fees, early upgrade fees and similar payments, irrespective of whether or not any such payments are described as compensation or damages.
Furthermore, the change will also have retrospective effect for suppliers who have received termination payments in VAT accounting periods that ended within the last 4 years and have treated those payments as outside the scope of VAT in line with previous HMRC guidance.
Given the significant change in UK VAT policy in this regard, if you have received a payment under a settlement agreement which was previously treated as outside the scope of VAT you will need to check whether VAT is now chargeable at your earliest convenience.
Posted on 12/11/2020 by Ortolan
