Guidance On VAT And Early Termination Fees


Guidance on VAT and early termination fees

December 05, 2020

Do you charge your customers compensation to withdraw from agreements to supply goods or services?  If yes you may have a question - Are charges to withdraw from agreements to receive goods or services vatable? Is there VAT on cancellation fees?

The answer is yes. They very well are part of the supplies of goods or services for which you have a contract with your customer.

Previously such charges were considered outside the scope of VAT. But now HMRC has changed this guidance. Following the CJEU judgments in Meo (C-295/17) and most recently in Vodafone Portugal (C-43/19) a new HMRC guidance is issued.

When you exit one contract and enter another say for example to upgrade your package it is now liable for VAT. Same applies to early upgrade fees. On failing to do so the concerned person need to correct the error. Regardless of whether the contract contains the right to terminate or not such fees are considered damage or compensation. Only when it doesn’t have any link between payment and supply of goods it might be outside the scope of VAT.

Do you have contracts with customers for minimum commitment period? Are your customers subject to termination fees for withdrawal? Then these updates are relevant to you.

What Should Now Be Done?

You may make the corrections in the next VAT Return. Action may need to be taken to recover the VAT paid from the customer.

How Not To Pay VAT On Early Termination Fees?

You need to have a ruling from HMRC stating those fees are outside the scope of VAT.

What If I Had A Ruling Earlier?

Such fees if received after September 2020 is to be accounted for VAT.

What About Breaches Of Contracts That Result In Termination Automatically?

Previously they were out of scope but now subject to VAT>HMRC treats them as further consideration of supply.

Why Change In VAT Guidance?

Previously they were out of scope but now HMRC acknowledges that such payments are though aimed at compensation yet as they arise from events contemplated under the contract, they are considered for what is provided under the contract.  The ECJ HMRC updated it manually after the ECJ’s (European Court of Justice) rulings in Meo and Vodafone Portugal. The brief published marks a significant change in HMRC’s previous position.

What About Liquidated Damages i.e. If The Amount Had To Be Paid For Loss Of Earnings?

It is subject to VAT now.

MEO :

In MEO the telecommunication services contract stated that on leaving the contract before time, a fixed sum was to be paid by the customer for the minimum commitment period. It was held by the CJEU that the termination payment was consideration for the right to receive the services which the customer chose not to use.

Vodafone Portugal :

In Vodafone Portugal, under Portuguese law, the termination payment was considered to Vodafone’s cost of providing the service. Vodafone tried to argue that the payment was intended as compensation. But the CJEU held that the amount payable on early termination was an integral part of the price the customer agreed to pay under the contract.

The payment was therefore considered subject to VAT.

What Will Change As A Result Of HMRC’s Updated Guidance?

HMRC will rarely accept that early termination and cancellation fees are not subject to VAT. The only exception might be when it does not have a direct link to a supply of goods or services in which case such payment may be outside the scope of VAT.

Affected businesses need to deal with this situation. Contact Doshi Outsourcing for VAT related assistance and to take care of all your needs.