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Important Changes to VAT on Early Termination Fees and Compensation Payments

On 2 September 2020, HMRC issued Revenue & Customs Brief 12 (2020) which completely overturns HMRC’s former published policy on whether a payment due on termination of a contract can be outside the scope of VAT as compensation.

Previous guidance stated at VATSC06720 (now deleted from the manuals on Gov.UK):

“There is no supply for VAT purposes of ‘the right to terminate’ or other such services where a contract originally contains a clause allowing the parties to terminate early in lieu of compensation for perceived losses arising from the termination. However, there will be supplies where no such right exists and agreements have separately to be reached properly to terminate the contracts. This is so even if there is much talk of monetary compensation in these agreements”

The new guidance at VATSC05920 states, “HMRC’s policy is to treat payments arising out of early contract termination as consideration for a taxable supply. Businesses must account for VAT on these fees. This applies in cases where the original contract allows for such a termination, as well as when a separate agreement is reached.”

The new HMRC guidance makes it clear that any charges described as compensation or early termination fees in a contract are generally liable for VAT. For example, charges made when exiting one contract and entering into another to upgrade a mobile telephone package or handset are therefore liable for VAT.

Please select this link to access the Revenue and Customs Brief 12 (2020): VAT early termination fees and compensation payments.

Please contact Mark Wildi if you would like to discuss any of the above information; on 01689 877081 or complete our online form.

This article, whilst provided to the best of our knowledge, is for general guidance only. More specific advice should be obtained before acting. We accept no liability for any action taken based on the above information.

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