HMRC announces significant change in its position on VAT treatment of compensation payments

Historically HMRC took the view that payments described as compensation were typically outside the scope of VAT.

It has now announced a change in its position in relation to:-

• Early termination of contracts
• Liquidated damages
• Payments for breach of contracts

Whether or not HMRC’s revised position is correct, I have concerns about HMRC’s announcement, in particular the lack of any transitional period or notice. Given that there will be live cases where parties are negotiating a settlement it would have been helpful if the new policy applied from a specified future date.

However, HMRC is saying that ‘any taxable person that has failed to account for VAT to HMRC on such fees should correct the error’. It appears to be expecting retrospective corrections unless a specific ruling has been obtained from HMRC to state that the fees are outside the scope of VAT (in which case the changes are prospective from the 2 September 2020).

Anyone who has attempted to obtain a ruling on a transaction recently, only to be told “read the guidance” may find this statement particularly frustrating.

Further, those that have applied the guidance in good faith may feel that they had a legitimate expectation that HMRC’s previous statements can be relied on.

Businesses and their advisers will need to review any payments which have historically been treated as outside the scope of VAT compensation or similar and consider their position carefully.

To read the brief and the changes, click here.

To discuss this further, please contact our VAT expert, Steve Chamberlain.