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HMRC has confirmed that VAT is now payable on most early contract termination and cancellation fees, in a change to its previous practice.
Previous guidance said that charges to withdraw from agreements to receive goods or services were not generally for a supply, and therefore fell outside the scope of payable VAT.
Following recent judgments of the Court of Justice of the European Union (CJEU), however, HMRC has said it is “evident that these charges are normally considered as being for the supply of goods or services for which the customer has been contracted for”.
In light of this, it stated these charges should therefore be subject to VAT.
Early termination and cancellation fees can now be liable for VAT following this change in guidance, even in cases where they are described as compensation or damages.
Following this announcement, HMRC is warning businesses that failed to account for VAT on these fees should “correct the error”.
According to the authority, if businesses have had a specific ruling from HMRC saying that such fees are outside the scope of VAT, they can only account for VAT on fees received after 2 September 2020.
Eloise Walker, a tax expert at law firm Pinsent Masons, said: “The suggestion that the VAT treatment of past payments needs to be revisited will cause a logistical nightmare.
“HMRC couldn’t have chosen a worse time to announce a retrospective change in practice, given that the coronavirus pandemic has resulted in very many more contract terminations than usual, and litigation settling that might otherwise go to court”.
Clara Boyd, a tax disputes expert at Pinsent Masons, said: “It’s not clear how far back HMRC is expecting people to look in ‘correcting’ the VAT position in relation to past payments.
“On other issues where HMRC have changed their guidance to bring it in line with recent case law authority, the tendency has been to apply the changes prospectively. It is unclear why HMRC have decided to apply these changes retrospectively.”
She added: “In the circumstances, the question will no doubt arise as to whether a taxpayer had a legitimate expectation that HMRC would follow their published guidance and therefore that they should not be required to revisit past treatment in accordance with that guidance.
“We would urge HMRC to think again and confirm that they will only apply this change in practice from the date it was announced or, preferably, a future date.”
