HMRC bombshell on compensation payments

In one of its recent Business Breifts HMRC Announced a reversal in its approach to compensation payments involving termination of contracts. More significantly it is applying the change retrospectively. How might this affect your business?

What’s Changed?

Until Business Brief 12 (2020) HMRC’s published approach to compensation paid for termination of an agreement was that payments were outside the scope of VAT. Since then its view is that virtually all such payments are subject to VAT. It expects you to look back at your records for the last four years and account for VAT on any such payments in that time.

VATable Transactions

It’s easiest to use an example to look at the sort of situation where HMRC’S new policy applies. Acom LLP had a long-term contract to provide cleaning services for several buildings owned by a property company. As a result of the pandemic, the company has lost tenants. A new contract with Acom was signed and the property company paid compensation for terminating the old contract. HMRC’s view is that payment is for a VATable supply relating to the original contract.

Consequences. Acom must issue a VAT invoice to the property company and account for VAT on the amount it paid. As the services Acom supplied under the contract were standard rated, one-sixth of the payment is VAT and must be paid to HMRC with its next return. The property company can reclaim the VAT included in the payment it made, subject to the normal rules.

Tip. The rules are different in respect of deposit payments given in advance of supplies being made. The rules for these haven’t changed. They may or may not be VATable depending on the circumstances in which they are paid.

Poor timing causing anger

Like other tax experts, we were stunned by the timing of this change by HMRC; it’s occurred at a time when compensation payments of the sort in question are probably more common than usual because of the distribution caused by coronavirus. It claims that the change was necessary because of two rulings by the Court of Justice of the European Union. However, the first of these dates back to November 2018; what has taken HMRC so long to act and why to backdate the change? Tax and accountancy bodies, while accepting the change are lobbying the government to make a U-turn regarding its retrospect effect. We’ll let you know if they succeed.

Take steps now

If you know or suspect you received a compensation payment that would now be VATable, ask your bookkeeper to check for a provide details of such payments. Check the payer’s details, e.g. current address and issue a VAT invoice to them showing the date of the transaction. Mark it as “paid”. It’s good practice to send a short covering letter referring the other party to HMRC’S Business Brief 12 (2020). Note that in the unlikely event you received a ruling from HMRC that a termination payment wasn’t VATable, and it was paid before 2nd September 2020, the new rule won’t apply.

Here to help

If you need to ask our expert team a question on any of the above please call us on 0330 2233660 we will be happy to assist. We will ensure we keep you updated as and when other annoucements are made.