HMRC have changed its guidance in relation to VAT on early termination fees and compensation payments following a recent judgement in the CJEU. This change will affect any businesses that charge cancellation fees to customers when they withdraw from agreements for the supply of goods or services.

Previously these charges were considered to be compensation for loss or damages and therefore outside the scope of VAT. However, following the CJEU judgement the courts have determined that these are actually a supply of goods or services, subject to VAT. This remains the case even if the contract describes them as compensation and/or damages.

Businesses that charge these types of fees will need to review the last 4 years VAT returns and check whether VAT was charged. If no VAT has been charged they will need to correct any errors and issue a corrected VAT invoice to the customer. Where errors are small (i.e. broadly no more than £10,000, or less than £50,000 and doesn’t exceed more than 1% of net sales) these can be corrected through the current VAT return. You may also want to consider writing to HMRC advising the of the error, so that it will be considered an unprompted disclosure in terms of deciding any penalties due. Where the VAT due is more than the above mentioned limits, this will need corrected on a VAT652.

Please get in touch if you think HMRC’s change in VAT treatment of termination fees will affect your business.