Prompt payment discounts are a useful way for suppliers to keep good customers happy and improve cash flow. However, the VAT rules on prompt payment discounts are changing and might make offering such discounts more of a burden than a benefit.

Historically, UK legislation allowed suppliers who offer prompt payment discounts to account for VAT on the discounted price, even if the customers did not take advantage of the prompt payment discount. New UK legislation that takes effect from 1 April 2015 states that suppliers must account for VAT on the consideration actually received for the supply.

This means that from 1 April 2015, suppliers will face an increased administrative burden. They will be required to issue invoices and account for VAT on the full invoice value. Then, if a customer takes advantage of the prompt payment discount, an adjustment will be required to the invoice and the VAT accounting.

Practical Steps

Suppliers should review their prompt payment discount policy and consider implementing some new procedures. Given the possibility that some customers may take advantage of the prompt payment discount but others will not, the supplier may wish to issue an invoice detailing not only the total consideration and VAT thereon but also the discounted price, the VAT on the discounted price and the total amount payable if the customer takes advantage of the discount. However, if the discount is taken up, the next procedural steps for the supplier are less clear. One option would be for the supplier to issue a credit note to the customer when the discount is taken up. This will provide a clear audit trail but will undoubtedly increase the supplier’s administrative burdens as each time a customer takes advantage of the prompt payment discount, a second updated invoice will need to be provided. The alternative would be for the supplier to simply adjust the VAT downwards in accordance with the discounted amount when the customer takes advantage of the discount on its own books and records. However, without the second updated invoice, the VAT audit trail will need to be satisfied using documentation other than a VAT invoice or credit note and this may lead to difficulties.

Given the challenges posed by this new legislation, the unintended consequence is that some suppliers may reconsider offering prompt payment discounts entirely – which will not be good for either the supplier or the prompt paying customer.