Following the European Court of Justice’s (ECJ) rulings in Meo and Vodafone Portugal, HMRC has recently updated its VAT manual and published a brief (https://www.gov.uk/government/publications/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments/) stating that payments arising out of early contract termination will now be treated as consideration for a taxable supply therefore subject to VAT. This marks a significant change from HMRC’s previous position that early termination payments described as compensation payments would ordinarily not be subject to VAT.
We reported on the so-called Vodafone Portugal case in the June edition of the UK Tax Round-Up (https://www.proskauer.com/newsletter/uk-tax-round-up-june-2020). In that case the ECJ considered that payments made by customers to Vodafone for terminating their contracts before the end of the contractual tie in period constituted consideration for a supply of services within the meaning of Council Directive 2006/112/EC (VAT Directive) so that VAT was payable on such fees. The ECJ held that the amount payable in the event of early termination should be considered an integral part of the price which the customer committed to paying to Vodafone to fulfil its contractual obligations and that the treatment of those termination fees as consideration for a supply accorded with economic reality.
HMRC’s previous guidance acknowledged the difficulties of determining whether a payment is compensatory or forms part of the consideration for a supply. HMRC drew a distinction between contracts with a “right to terminate” and contracts which do not have such a right. HMRC’s previous position was that generally when customers have to make a payment to withdraw from agreements to receive supplies of goods or services such termination payments are not generally treated as consideration for a supply and were therefore outside the scope of VAT. We noted in the June Round-Up the possibility that HMRC would update its guidance in light of the ECJ’s decision. This week it has. Below are the key updates:
- Most early termination payments will now be treated as consideration for the supply of goods or services for which the customer has contracted for. Early upgrade fees will be treated in the same way. Therefore these payments will be subject to VAT. This is the case irrespective of whether the contract contained such a “right to terminate” and whether or not the fees are described as “compensation” or “damages”. It is only where there is no direct link between a payment and a supply of goods or services that it might be outside the scope of VAT.
- Liquidated damages are now treated as consideration for a supply. HMRC’s previous guidance stated that such amounts were outside the scope of VAT. In its updated guidance HMRC acknowledges that although such payments are aimed at compensating they arise from events contemplated under the contract therefore are consideration for what is provided under the contract. Similarly, liquidated damages payments for early termination by lessees under lease agreements for moveable goods (for example vehicle finance leases) were previously treated as outside the scope of VAT (subject to any agreement with the leasing industry that allowed lessors to treat such payments as taxable supplies). These payments are now treated by HMRC as taxable.
- HMRC’s previous guidance stated that payments for breaches of contract which resulted in automatic termination of the contract or entitled the supplier to terminate the contract were outside the scope of VAT. Such payments are now treated by HMRC as further consideration for a supply.
HMRC’s updates are particularly relevant for businesses which have contracts with customers for minimum commitment periods and customers are subject to termination fees for withdrawal. A business that has failed to account for VAT on such fees should correct such error unless a specific ruling has been obtained from HMRC stating that such fees are outside the scope of VAT.