VAT alert - Compensation vs Consideration for a supply

Rob Geary
HM Revenue and Customs

Previously, HMRC guidance stated that when customers are charged early termination fees to withdraw from contracts, or payments are required for breach of contract, then these charges are not generally relating to a supply and are outside the scope of VAT.

HM Revenue and Customs

Following a couple of European Court of Justice decisions, HMRC have updated their guidance to clarify that these charges will normally be considered as being consideration for a supply and will likely be liable to a VAT charge where there is a direct link between the supply and the amounts paid.  Examples of these kinds of charges could be:

  • Fees for exiting a mobile phone contract
  • Early termination fees for ending a commercial lease
  • Damages relating to breach of contract, where the initial contracted supply was taxable for VAT purposes

HMRC expect businesses that have failed to account for VAT on these fees in the past to correct these errors, unless they have received a specific ruling from HMRC that their charges can be treated as outside the scope compensation payments. Only where there is no direct link between a payment and a supply of goods or services may ‘compensation’ payments be considered outside the scope of UK VAT. Examples of these could be:

  • Damages are paid following unauthorised use of a trademark or logo
  • Government compensation payments to farmers for preventing crop growth

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