Prior to the issue of this Business Brief, such payments would have been considered outside the scope of VAT on the basis that they are compensatory payments for terminating such contracts early. This was in line with all HMRC guidance.
The Business Brief has been issued following two CJEU decisions, both which relate to telecoms companies and the VAT treatment of early termination payments. In one of these cases, the early termination payments were equal to the full amount remaining as per the contract. In the other, the amount that the customer had to pay was less than what would be payable if the contract would have been fulfilled, but the court ruled that the amount paid was an integral part of the price that the customer had committed to pay.
In both instances, the CJEU ruled that in any event, the payment related to goods and or services, whether or not they were used by the customer, and so and VAT was due on such payments. It also goes on to say that if such payments are described as compensation or liquidated damages, VAT would still be applicable.
Looking at this in a wider context, it is anticipated that the guidance will apply to all commercial contracts including those involving property. Payments as a result of break clauses in leases will be affected by this. Ordinarily, such payment would be deemed to be compensation and so outside the scope of VAT. The updated guidance from HMRC suggests that this would no longer be the case. What it doesn’t specify is if such lease is exempt from VAT, would such payment be exempt or would that also be taxable? Hopefully HMRC will clarify this point at some point.
More worryingly, the new guidance seems to suggest that if taxpayers have treated such payments as outside the scope of VAT in the last 4 years, they now have to make an error correction to rectify this, making such changes retrospective. This is unusual as HMRC normally update guidance and it is usually effective from that date. This means, that if you have received such payment during the last four years and not accounted for VAT on it, HMRC now want 20% of the amount received, albeit had this been in effect at the time the payment was received, the amount would have been received plus VAT.
As above, in due course HMRC will hopefully make clear their intentions regarding such payments. The retrospective application of such guidance couldn’t have come at a worse time with commercial property businesses struggling after Covid, with some of them not having received any rental income since March.
So where do we go from here then? It seems that all payments of this nature will be subject to VAT. The updated guidance states that, “it is only where there is no direct link between a payment and a supply of goods or services that it may be outside the scope of VAT”. This pretty much rules out most compensation payments on the basis that compensation is normally paid when one party is in breach of contract and that contract would ordinarily be for the supply of goods or services.
If you have received such payment during the last four years and are unsure as to what your next steps are or you have any questions regarding the above, please speak to Michelle Dale or your usual UHY adviser.
