Amidst the COVID 19 chaos on September 2, 2020, HMRC has suddenly taken a reverse stand on early termination fees, announcing such fees are now dependent on VAT. The issue is concerned with the VAT treatment of payments a business charges to enable clients to withdraw from agreements early. For example – cancelling a yearly subscription part-way through a year. What exactly this means?

Earlier, these charges were not associated with taxable supply, and so these were not within the scope of VAT. However, HMRC has changed its opinion after following two CJEU judgments. So, in the present condition, these charges will be liable for VAT. HMRC emphasises that this will be the case even if they are defined as damages or compensation.

Both suppliers and customers must be aware of this issue. Businesses that make exempt supplier or exempted partially won’t be able to claim VAT charge as input. As the policy change is retrospective, suppliers who are paid compensation fees might face a large assessment for the VAT due on previous supplies.

Given the chaotic situation in 2020, it is quite likely that we will see more such issues where contracts are being cancelled or terminated before the end of the agreement date. However, businesses must apply for the new treatment from September 2, 2020, if they have received a written guideline from HMRC earlier that their cancellation or termination fees were not within the scope. In such a case, they will not require to make adjustments with the previous VAT returns.