Change in UK VAT treatment of contract terminations won't be retrospective

Out-Law News | 29 Jan 2021 | 9:08 am | 2 min. read

A change in practice by UK tax authority HM Revenue & Customs (HMRC) as to when VAT will be payable on contract terminations and other damages paid in relation to a contract will not be retrospective, HMRC has announced.

On 2 September 2020, HMRC made a surprise announcement in Revenue & Customs Brief 12/2020 that as a result of Court of Justice of the European Union (CJEU) case law, it was changing its published guidance on the VAT treatment of both early termination payments and other compensation payments relating to commercial contracts. In that brief HMRC set out a new general rule that most such payments would now be subject to VAT instead of outside the scope of VAT as the guidance previously stated.

The brief said that taxpayers who had failed to account for VAT to HMRC on payments affected by the change in practice should "correct the error", unless they had a specific ruling from HMRC saying that such fees were outside the scope of VAT, when the new practice only had to be applied from 2 September.

Walker Eloise

Eloise Walker

Partner, Head of Corporate Tax

This confirmation that the change will not be retrospective at least means that the many contract terminations which took place as a result of the coronavirus pandemic no longer need to be revisited.

In the new announcement HMRC said: "After communication from businesses and their representatives, HMRC has decided to apply the updated VAT treatment set out in [Brief 12/2020] from a future date".

HMRC said it will issue revised guidance, and a new Revenue and Customs brief to explain what businesses need to do "shortly". HMRC said it would also give guidance on what to do if taxpayers had already changed the VAT treatment of payments because of the brief. In the meantime, HMRC said businesses can either apply the new practice and continue to treat payments as subject to VAT or go back to treating them as outside the scope of VAT in accordance with HMRC's former guidance.

"Finally HMRC has abandoned the suggestion that its change of policy could be implemented with retrospective effect," said Eloise Walker, a tax expert at Pinsent Masons, the law firm behind Out-Law.

She said the suggestion that the brief should be applied retrospectively was "especially controversial" because it "came out of the blue" and it was "unfair and unworkable" to expect businesses to look back 4 years potentially to a time before the publication of the CJEU judgments which caused HMRC to change its practice.

"Once you have settled a commercial dispute it is seldom possible to go back and ask for another 20% so imposing VAT at a later date is likely to just leave the recipient of the damages out of pocket," Walker said.

"This confirmation that the change will not be retrospective at least means that the many contract terminations which took place as a result of the coronavirus pandemic no longer need to be revisited," she said.

"We will have to wait for the revised guidance to hear exactly how much notice HMRC has taken of the outcry over all the situations when its change of practice will apply, particularly in relation to damages for breach of contract rather than early termination," Walker said.

"There are particular concerns in relation to property transactions, which were ignored in the guidance originally issued - especially dilapidation payments under leases," she said.