HMRC's change of practice on VAT and compensation payments

Revenue & Customs Brief 12/2020 and new guidance in its VAT Supply and Consideration Manual confirms that HMRC will now generally see compensation and early termination fees as subject to VAT.

The new guidance indicates that developments in EU case law have led HMRC to conclude that many payments described as compensation (and typically treated as outside the scope of VAT) are actually consideration for supplies. As a consequence, HMRC’s policy is now to treat payments arising out of early contract termination as consideration for a taxable supply (VATSC05920).

Liquidated damages, which HMRC previously explicitly stated were outside the scope of VAT in VATSC06730, are now viewed as consideration for a supply (VATSC05930).

Payments for breach of contract, which HMRC also explicitly stated were outside the scope of VAT in VATSC06730, are now seen as further consideration for a supply (VATSC05930).

HMRC states that ‘any taxable person that has failed to account for VAT to HMRC on such fees should correct the error’. It appears that retrospective corrections are therefore expected unless a specific ruling has been obtained from HMRC to state that the fees are outside the scope of VAT (in which case the changes apply from 2 September 2020).

Businesses and their advisers are advised to review any payments which have historically been treated as outside the scope of VAT compensation or similar and to act accordingly.