Policy paper

Revenue and Customs Brief 2 (2022): VAT early termination fees and compensation payments

Published 7 February 2022

Purpose of this brief

This Brief replaces Revenue and Customs Brief 12 (2020): VAT early termination fees and compensation payments. It introduces a revised policy on early termination payments and compensation payments. Following representations from industry the Brief and guidance issued in September 2020 was suspended in January 2021. HMRC has reviewed the policy in the light of those representations and is adopting a revised policy which will take effect from 1 April 2022. The revised policy will result in fewer payments being regarded as within the scope of VAT by HMRC than the policy set out in 2020.

This Brief gives an update on the VAT treatment of early termination, compensation and similar payments. It also advises businesses that adopted the treatment outlined in Brief 12 (2020) on what action they should take.

Who needs to read this Brief?

Anyone who charges their customers to withdraw from agreements to supply goods or services.

Background

VAT is a tax on the supply of goods and services. Previous HMRC guidance stated that when customers are charged to withdraw from agreements to receive goods or services, these charges were not generally for a supply and were outside the scope of VAT.

Following the Court of Justice of the European Union (CJEU) judgments in Meo (C-295/17) and most recently in Vodafone Portugal (C-43/19), it is evident that some of these charges are additional consideration for the supply of goods or services. Most early termination fees and some cancellation fees are therefore liable for VAT if the goods or services for which the fees have been paid are liable for VAT, even if they are described as compensation or damages.

What is the change?

HMRC policy on early termination fees and similar payments is changing from 1 April 2022. Our guidance manuals on charges described as compensation or early termination fees, are being changed to make it clear when HMRC considers they are payments for a supply and potentially liable for VAT.

The main impact of the revised policy is that fees charged when customers terminate a contract early will be regarded as further consideration for the contracted supply. For example, if a customer is charged a fee for exiting a mobile phone contract early, or if they terminate a car hire contract early, it will be liable for VAT.

This does not affect the tax treatment of full or part payments made on account for a taxable supply, which is explained in Revenue and Customs Brief 13/18.

Businesses making supplies subject to the Tour Operators’ Margin Scheme, can find out more information in the Revenue and Customs Brief 09/19.

The new guidance can be found at VATSC05910, VATSC05920 and VATSC05930.

The guidance VATSC06710, 06720 and 06730 has been withdrawn. The suspended September 2021 version of guidance VATSC05910, VATSC05920 and VATSC05930 is also withdrawn.

Action

All businesses must adopt the revised treatment no later than 1 April 2022. This includes any taxable person that has had a specific ruling from HMRC saying that such fees are outside the scope of VAT.

Businesses that adopted the revised treatment for payments that are further consideration for supplies should continue to treat these supplies in accordance with the revised policy.

Any business that adopted the treatment outlined in the guidance published in September 2020 and accounted for VAT on transactions which under the latest guidance are outside the scope of VAT may correct this in the normal way — see the guidance on error correction.