This blog is a follow-up to our recent blogs on HMRC’s controversial Changes to VAT and Early Termination Payments and VAT on Compensation in Intellectual Property Settlements. As previously noted, the retrospective nature of the changes and the consequential risk of having to unpick historic settlement payments raised a number of issues. This has now resulted in HRMC’s plans to issue further guidance on the subject.

Background

In September 2020 the UK’s HM Revenue & Customs (“HMRC“) updated its guidance on the VAT treatment of contractual compensation payments for early termination of commercial contracts.

The guidance, which is underpinned by HMRC’s interpretation of EU case law, treated contract termination payments (including for breach or withdrawal or under liquidated damages clauses) as consideration for supplies for VAT purposes. The result of such treatment is that VAT was potentially chargeable, depending on the nature of the underlying supply. This raised alarm bells, because termination payments had previously been treated as outside the scope of VAT. The new rules require parties to distinguish between:

• On the one hand: pure payments of compensation, which are potentially outside the scope of VAT; and

• On the other hand: payments that constitute consideration for VAT, such as for a variation or early termination of a contract.

However, it was the retrospective nature of the changes which was really problematic, because it gave HMRC the power to revisit historic settlements over a four year lookback period.

Where we are now

At the end of January 2021, HMRC further updated its guidance (see here). It appears that HMRC has listened to the feedback from the business community – it has decided to apply the updated VAT treatment set out in its guidance only on a prospective basis, rather than the retrospective application that was previously suggested.

Next steps

 This is of course a welcome temporary halt to the proposed changes set out under the revised guidance. HMRC will issue revised guidance and a new Revenue and Customs brief to explain what businesses need to do shortly. This will include guidance on what to do if businesses have already changed how they treat such payments because of the previous HMRC announcement.

Until the new guidance is issued, businesses can either:

• continue to treat such payments as further consideration for the contracted supply; or

• go back to treating them as outside the scope of VAT, if that is how they treated them before HMRC changed the rules.

Blog written with support from trainee solicitors Sera Kaplan and Sarah Roughton.