HMRC have published Revenue and Customs Brief 2 (2022) ‘VAT early termination fees and compensation payments’. This details their revised policy effective from 1 April 2022 and clarifies the VAT treatment of dilapidations.

Background

  • HMRC’s previous guidance stated that when customers are charged to withdraw from agreements to receive goods or services, those charges were not generally for a supply and were therefore outside the scope of VAT.
  • Two Court of Justice of the European Union (CJEU) cases established that some early termination fees and compensation payments are in fact additional consideration for the supply of goods or services.
    • This meant that most early termination fees and some cancellation fees were liable for VAT, where the contracted goods or services were themselves liable for VAT.
  • This revised position was outlined by HMRC in Revenue and Customs Brief 12 (2020), published in September 2020.
  • In January 2021, this guidance was suspended, with further clarification expected at a later stage. This left businesses with the option to either:
    • Treat the payments as further consideration for the contracted supply.
    • Revert to treating the payments as outside the scope of VAT.

New guidance: Revenue and Customs Brief 2 (2022)

Following industry representations, HMRC have now published new guidance.

  • The main impact is that, from 1 April 2022, fees charged when a customer terminates 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 it will be liable for VAT.

Under the previous guidance issued in September 2020, it was considered likely that dilapidation payments would fall within the revised policy and so be subject to VAT where the underlying property was subject to an Option to tax.

  • The new guidance now published addresses this point: HMRC will not generally treat dilapidation payments as further consideration for the supply of the lease.    

HMRC’s detailed revised guidance can be found in the VAT Supply and Consideration Manual at VATSC05910, VATSC05920 and VATSC05930.

Next steps

  • The revised treatment applying to early termination fees and compensation payments must be adopted no later than 1 April 2022.
    • This includes cases where HMRC have previously given a ruling stating that such fees are outside the scope of VAT.
  • Businesses that adopted the treatment in Revenue and Customs Brief 12 (2020) and accounted for VAT on transactions that are now considered outside the scope of VAT may Correct this in the normal way

Useful guides on this topic

Correcting VAT errors
What are the VAT error correction time limits? Can you correct errors through the VAT return? Do you have to notify HMRC?

Land & Property VAT
An outline of the VAT treatment of some of the more common supplies of land and property.

Opting to tax land and property
What is an option to tax? What do I need to do to opt to tax? What happens if I buy an opted property?

Mixed supplies: Single or Multiple supply?
Is a mixed supply a single or multiple supply for VAT purposes? What tests and case law apply?

External links

Revenue and Customs Brief 2 (2022): VAT early termination fees and compensation payments

HMRC manuals: 

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