On 2 September 2020 HMRC announced that the VAT treatment of cancellation and early termination fees had changed.  In the past these payments have usually been regarded as compensation and so outside the scope of VAT.  However, following two EU cases on cancellation and early termination fees involving mobile phone contracts it was decided that these payments were further payments due under the contract and so had the same VAT status as other payments for goods and services made under the same contract. The changes to HMRC’s policy were set out in Revenue and Customs Brief 12 (2020).

There were two controversial aspects to the changes:

  1. It was clear that VAT would apply to a wide range of payments that had previously been regarded as compensation such as some payments for breach of contract and some payments for dilapidation.
  2. The change was retrospective; HMRC invited businesses to correct their VAT returns covering the previous four years for underdeclared VAT on income now regarded as taxable.

There have been widespread objections to HMRC’s approach and HMRC are now carrying out further consultation on the scope of the changes.  In the meantime they have announced that the changes will now take effect from a future date, to be announced.

When a revised Brief is issued HMRC will also advise what can be done if businesses have already made retrospective adjustments.

Until the revised Brief is issued businesses can either treat cancellation and early termination fees in the same way as other payments under the same contract, or they can treat them as outside the scope of VAT, if this is how they treated them before 2 September 2020.