There have been a number of recent judgements from the Court of Justice of the EU (CJEU) concerning early termination fees. These have resulted in a review of HMRC policy which could have a widespread effect across many sectors. One example is to bring payments that allow customers to withdraw from or terminate agreements for goods or services within the scope of VAT.
Effect of change in policy
HMRC’s policy change was announced on 2 September 2020 with immediate effect. For businesses that have not accounted for VAT on termination payment, they have a potential exposure for the previous four years. Only those taxpayers who have received a specific ruling from HMRC, confirming that their income falls outside the scope of VAT, are likely to be protected from HMRC’s reconsideration of their historic position.
VAT is due on a supply of goods or services for a consideration. VAT is therefore applied to most supplies made by VAT registered businesses for consideration. A supply of services includes anything which is done for a consideration.
The judgements from the CJEU in MEO (C-295/17) and Vodafone Portugal (C-43/19) helped clarify the position in relation to payments for early termination of telecoms contracts. The court decided that payments, set out in the agreements, made by customers to terminate their contracts early, were part of the agreement to provide services. So, payments due by customers were part of the consideration for supplies made and were taxable consideration.
Genuine compensation to recompense for a loss, where the payment is non-contractual and so not linked to an agreement to make any supply, may still fall outside the scope of VAT. However, if a payment is labelled as compensation, that may not be the case. The key is whether it is linked to any supply. Given the broad meaning of a ‘supply’ this can, for example, extend to provide the right to early termination of a contract or for giving or surrendering a right to something.
Businesses affected by this change of policy should review the treatment of such receipts or payments over the past four years and consider if they were correct to treat such payments as outside the scope of VAT, or if they now have an exposure to output VAT. In the payer’s case, they should consider if they were correct to deduct input VAT on a supply which VAT has been wrongly charged. The terms of any agreement under which payment was made will also need to be considered, to determine whether a payment should be treated as inclusive or exclusive of VAT.
If your business has received or made compensatory payments in the last four years, such as in the event of contract termination, liquidated damages, breaches of contract or pursuant to lease agreements, then it may be advisable to seek professional advice on the VAT treatment of these. You should establish what action to take to correct any errors which may have been made.
If you are in any doubt on the impact of the policy change to your business, please get in contact with your usual PKF contact or a member of PKF’s VAT team.