VAT on contract cancellation fees

by | Oct 1, 2020

 

Some of our clients are finding themselves having to either re-purpose or structure their business as a result of the Covid-19 pandemic.  This has for some resulted in the termination of supplier service contracts for power, telecoms, or security. Early termination of those contracts can, in some instance, trigger a cancellation fee.

In the past such cancellation fees were regarded as outside the scope of VAT as no goods or service were being provided for the consideration. However, two European Court of Justice cases involving telecoms companies have determined that cancellation fees are part of the agreement to supply the services, so they should be subject to VAT in the same manner as the service provided.

HMRC has set out its revised view on cancellation and termination fees in Revenue and Customs Brief 12/2020 published on 2 September. However, this doesn’t just affect cancellation fees paid from that day forward, the change in VAT treatment is retrospective.

Where a charge for cancellation fees has been applied in the last four years, checks should be made as to how they accounted for VAT on that fee, and what rate of VAT applied to underlying service. For example, venues frequently charge a cancellation fee if a booking is cancelled within a set period. (There are special rules for tour operators who use TOMS, as explained in Revenue & Customs Brief 9/2019.)

If VAT should have been charged the supplier needs to issue a corrected VAT invoice to the former customer. The supplier will also have to correct the error which has understated VAT due in earlier returns.

Where the understated VAT is no more than £10,000, or is less than £50,000 and doesn’t exceed more than 1% of net outputs (box 6), that error can be corrected on the current VAT return. Where the understated VAT is more than £50,000 the correction must be made using form VAT652.

If cancellation fees have been paid during the last four years, attempts should be made to contact the supplier for a corrected VAT invoice. The supplier should not charge additional VAT on top of what has been paid as the cancellation fee, the VAT should be treated as part of the fee already paid.

Once the corrected invoice has been received, the customer can reclaim the VAT, using the same error correction limits above.

If you wish to speak to a member of our team regarding this or any area of VAT please contact us on 020 7330 0000.  

Additional useful information

https://www.gov.uk/guidance/how-to-correct-vat-errors-and-make-adjustments-or-claims-vat-notice-70045#VAT-errors-submitted

https://www.gov.uk/government/publications/revenue-and-customs-brief-12-2020-vat-early-termination-fees-and-compensation-payments

https://www.gov.uk/government/publications/revenue-and-customs-brief-9-2019-vat-tour-operators-margin-scheme-and-retained-payments-and-deposits

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