News added on 14.09.2020

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Cancellation fees

VAT: HMRC changes policy on early termination fees

On 2 September, HMRC issued a Brief which is concerned with the VAT treatment of payments a business charges to allow customers to withdraw from agreements early, for example cancelling an annual subscription part-way through a year. What do you need to know?

What’s the crux? Previously, such charges were generally not related to a taxable supply, and so were outside the scope of VAT. However, following two CJEU judgments HMRC has changed its view. Now, the position is that these charges will generally be liable for VAT. HMRC stresses that this is the case even if they are described as compensation or damages.

Who needs to know? This issue is important for both suppliers and customers. A VAT charge will not be claimable as input tax by a business that makes exempt supplies, or is partially exempt. And suppliers receiving compensation fees could be faced with a large assessment for VAT owed on past supplies, as the policy change is retrospective.

Example. Mary trades as an insurance broker and is dissatisfied with the services provided by the office cleaners at her premises. She has decided to cancel the contract but must pay a termination fee equal to six months of cleaning fees to the supplier. HMRC now regards the charge by the cleaners as being subject to VAT, even though no cleaning work will be done in return for this payment. This will be an extra cost to Mary because her insurance business is partially exempt and cannot fully claim input tax.

Other charges not affected. Despite the radical change of policy by HMRC, there will still be some compensation payments that will be outside the scope of VAT. For example, penalties and fines that are charged as a result of customer behaviour will still be VAT free in most cases.

The HMRC Brief is available here

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