VAT on compensation payments

HMRC has published a new Revenue and Customs Brief on the VAT treatment of early termination fees and similar compensation payments following recent judgments of the Court of Justice of the European Union (CJEU). HMRC has said that this will impact anyone who charges their customers to withdraw from agreements to supply goods or services.

Previous HMRC guidance said when customers are charged to withdraw from agreements to receive goods or services, these charges were not generally for a supply and were outside the scope of VAT.  

Following the CJEU judgements, HMRC is of the opinion that these charges are normally considered as being for the supply of goods or services for which the customer has been contracted. Most early termination and cancellation fees are therefore liable for VAT. This is the case even if they are described as compensation or damages. 

HMRC guidance on charges described as compensation or early termination fees in a contract, have been changed to make it clear that they are generally liable for VAT. This marks a significant change from HMRC’s previous position that early termination payments described as compensation payments would ordinarily not be subject to VAT.

A business that has failed to account for VAT on such fees should correct the error unless a specific ruling has been obtained from HMRC stating that such fees are outside the scope of VAT. 

VAT – partial exemption defined

A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes. This means that the business is required to make an apportionment between the activities using a 'partial exemption method' in order to calculate how much input tax is recoverable.

HMRC’s guidance explains that as a VAT-registered business, you can recover the VAT on your purchases which relates to taxable supplies that you make or intend to make. There are some items where input tax recovery is ‘blocked’. Supplies that are made outside the UK that would be taxable if in the UK and certain exempt supplies to non-EU customers also give the right to recover VAT, but there are special rules. In principle, you cannot recover VAT that relates to any exempt supplies, although you may be able to if the VAT is below certain limits.

There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could prove distortive. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual use of inputs. It is possible to agree a special method with HMRC.

The VAT incurred on exempt supplies can be recovered subject to two parallel de-minimis limits.

Changes to VAT partial exemption

HMRC has updated its guidance on the VAT partial exemption treatment relevant to businesses who supply goods by way of hire purchase agreements. A policy paper entitled Revenue and Customs Brief 8 (2020): change to partial exemption VAT treatment was first published on 10 June 2020 and updated on 20 August 2020.

The policy paper was released following the Court of Justice of the European Union (CJEU) judgment C-153/17 Volkswagen Financial Services (UK) Ltd.

HMRC’s view is that a business supplying goods on hire purchase should be allowed input tax recovery on its overheads where the recovery is fair and reasonable. It does not follow that the recovery will simply be fifty-fifty.

In the policy paper, HMRC provides details of its recommended method for an output values-based method of apportionment of VAT incurred on overheads. The method set out is HMRC’s preferred industry method but is not compulsory and businesses can continue to apply any fair and reasonable partial exemption method already agreed with HMRC.

Why use the VAT Cash Accounting Scheme

Under standard VAT accounting, you pay VAT on your sales regardless of whether your customer has paid you. Under the Cash Accounting Scheme, VAT does not need to be paid over until your customer has paid your invoice.

Your business can enter this scheme provided your estimated VAT taxable turnover for the next VAT year is not more than £1.35 million. You can continue to use the scheme until the VAT taxable turnover exceeds £1.6 million.

Using cash accounting may help your cash flow, especially if your customers are slow payers. If a customer never pays you, you do not have to pay VAT on that bad debt as long as you continue to use the Cash Accounting Scheme.

However, there are downsides to the use of this scheme. For example, you cannot reclaim VAT on your purchases until you have paid your suppliers. This can be a disadvantage if you buy most of your goods and services on credit. The scheme is also not advised if you regularly reclaim more VAT than you pay. You will usually receive your repayment later under cash accounting than under standard VAT accounting unless you pay for everything at the time of purchase.

If you are interested in using the scheme we can help you crunch the numbers to see if this is a viable option for your company.

VAT option-to-tax changes extended

To accommodate coronavirus disruption HMRC temporarily changed the time limit from 30 to 90 days for notifying a VAT option-to-tax for land and buildings. This extension was set to expire on 30 June 2020 but has been extended to 31 October 2020.

The option to tax rules allows businesses to make an election to standard rate the supply of most non-residential and commercial land and buildings. This means that subsequent supplies by the person making the option to tax will be subject to VAT at the standard rate.

The ability to convert the treatment of VAT exempt land and buildings to taxable can have many benefits. The main benefit is that the person making the option to tax will be able to recover VAT on costs (subject to the usual rules) associated with the property including the purchase and refurbishment of the property.

However, any subsequent sale or rental of the property will attract VAT. Where the purchaser or tenant is able recover the VAT charged this is not normally an issue. However, where the purchaser / tenant is not VAT registered or not fully taxable (such as bank) the VAT can become an additional (non-recoverable) cost.

Once an option to tax has been made it can only be revoked under limited circumstances. This includes within a specified 'cooling off' period in the first 6 months. An automatic revocation applies where no interest has been held for more than 6 years and after 20 years has elapsed.

Temporary 5% VAT rate and the Flat Rate Scheme

HMRC has published new guidance for VAT registered businesses in the hospitality, holiday accommodation and attractions sectors. This new guidance follows the Chancellor’s announcement in the Summer Statement of a temporary reduction in the VAT rate from 20% to 5% from 15th July 2020 until 12th January 2021.

This means that until the 12th of January 2021, VAT charged on food, accommodation and certain attractions (such as eat-in or takeaway food in restaurants, cafes and pubs, cinemas, theme parks and zoos) will be reduced to 5%.

In respect of the VAT Flat Rate Scheme, the guidance states ‘If you are a small business and use the Flat Rate Scheme to simplify your VAT calculations you should be aware that certain percentages have been reduced in line with the introduction of the temporary reduced rate of VAT’.

The relevant link that displays the Flat Rate Scheme percentages do not appear to have changed as yet but are expected to be updated shortly. The change in flat rates should be made to affected clients' accounts software.

 

Reclaiming VAT after deregistration

Businesses can close a VAT registration for two main reasons. For example, the business has stopped making taxable supplies or a voluntary deregistration can be made by businesses that does not expect its taxable turnover to exceed the deregistration limit. The current deregistration limit is £83,000.

A business that deregisters will be required to submit a final VAT Return for the period up to and including the VAT deregistration date.

Regardless of the reason for deregistration, businesses remain eligible to reclaim input tax relating to the time when the business was VAT registered after the final VAT return has been submitted. Such a claim is made using form VAT 427.

The form can be used to:

  • reclaim VAT paid (input tax) on purchases when you were VAT registered
  • reclaim VAT paid (input tax) on certain services you bought after you cancelled your VAT registration
  • get relief on the VAT you paid to HMRC (output tax) on bad debts that you identified after you cancelled your VAT registration.

UK VAT claims by non EU businesses

There are special rules for businesses established outside the EU submitting a claim for VAT incurred on goods or services bought in the UK. The exact rules that determine what VAT is refundable can be complex. There are also a number of conditions which must be met in order for a claim to qualify.

The deadline for the submission of a refund request for expenses incurred in the UK by non-EU businesses during the period 1 July 2018 – 30 June 2019 was 31 December 2019. HMRC has reported that due to the impact of Coronavirus there are some delays in making repayments. HMRC generally aims to process and refund overseas VAT claims within 6 months of the submission deadline of 31 December 2019 i.e. by 30 June 2020. HMRC now expects to pay valid 2018-2019 claims by 30 September 2020. HMRC will contact claimants whose VAT claims will not be paid by 30 September 2020 either because further information is needed or for any other reason.

HMRC is also reminding those concerned that claims for 2019-20 need to be submitted by 31 December 2020. One of the conditions for making a claim is for the claimant to obtain the required certificate of status from their official issuing authorities. This may not be possible due to measures taken by jurisdictions in response to Coronavirus. Claimants who submitted their VAT refund claim without a certificate of status will not have their claim rejected, but it will be put on hold until 31 December 2020. HMRC should be contacted for further case specific advice if obtaining a certificate of status before 31 December 2020 is likely to be problematic.

Time to revisit VAT Flat Rate Scheme?

The VAT Flat Rate scheme is intended to simplify the way a business accounts for VAT and reduce the administration costs of complying with the VAT legislation. There can also be a decent VAT saving for those using the scheme.

The scheme is only open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000, excluding VAT. If you have clients whose turnover has reduced to this level as a result of the Coronavirus pandemic, then it may be worth reconsidering the scheme.

Under the Flat Rate scheme, businesses simply pay VAT as a fixed percentage of their VAT inclusive turnover. When using the scheme, the amount of VAT paid on business expenses becomes irrelevant. This is quite different to the normal VAT accounting procedure where simply putting the VAT paid to HMRC is the difference between the VAT charged to customers and the VAT paid on purchases.

The actual percentage used depends on the type of business. There are special rules for those classed as a limited cost business who must use a flat rate of 16.5%. This will negate the benefit of joining the scheme.

In addition to the turnover limit you cannot use the scheme if:

  • You left the scheme in the last 12 months,
  • You committed a VAT offence in the last 12 months,
  • You joined or could have joined a VAT group in the last 24 months,
  • You registered for VAT as a business division in the last 24 months
  • Your business is associated with another business,
  • You have joined a margin or capital goods scheme.

Once you join the scheme you can continue using the scheme once your total business income does not exceed £230,000 in a 12 month period. There are some special rules if the increased turnover is temporary. There is also a first year discount for businesses in their first year of VAT registration of 1%.

Deregistering for VAT

A voluntary VAT deregistration can be made if you do not expect your taxable turnover to exceed the VAT deregistration limit. The current deregistration limit is £83,000.

If you are running a small business that has been adversely affected by the Coronavirus pandemic, this could be an opportune time to consider whether or not to voluntarily deregister. The deregistration cannot be backdated and must be from a current or future date where you expect sales in the next 12 months to be less than £83,000.

A compulsory VAT deregistration is usually required if you:

  • Stop making taxable supplies
  • Sell your business
  • Change legal status
  • Disband a VAT group
  • Join a VAT group
  • Join the agricultural flat rate scheme

You will be required to submit a final VAT Return for the period up to and including the VAT deregistration date.

If you are considering voluntarily cancelling your VAT registration, there are a number of issues that must be considered. Whether or not this is a good idea depends on your specific circumstances. We would be happy to help you consider your options.

If you mainly sell goods or services to individuals who have not been able to reclaim the VAT you charge, deregistration may help you to restore a competitive advantage.