VAT due on compensation payments – the implications for the property and construction sector
Until recently, the default position was that compensation payments were outside the scope of VAT. However, recent guidance from HMRC has changed this position. This is as a result of decisions by the UK courts and the European Court of Justice.
HMRC’s revised guidance on compensation payments, which have previously been treated as outside the scope of VAT, in line with Revenue guidance, may now be treated as consideration for a taxable (or exempt) supply for VAT purposes.
What was the position previously?
Formerly, the default position was that compensation payments were outside the scope of VAT as they weren’t consideration for a supply. This meant that where a lease contained a compensation provision, for example where a compensation payment arises for early termination, the payment would not be subject to VAT, unless an option to tax had been made by the party receiving the payment.
What is the new position?
The new guidance from HMRC makes it clear that compensation payments (or payments described as ‘compensation or damages’) are now generally liable to VAT.
In the property and construction sector, HMRC’s guidance should be considered carefully in the context of payments such as:
- Break payments under leases (whether included in the lease or otherwise);
- Forfeited contractual deposits;
- Dilapidations payments; and
- Liquidated damages payable pursuant to development agreements and agreements for lease.
These payments may now be considered a payment for a supply and, if so, will be liable for VAT.
The new position is retrospective
HMRC’s guidance also advises that the new position will be retrospective and HMRC states that any taxable person that has failed to account for VAT to HMRC on such fees should correct the “error”, within the usual timescales – potentially requiring VAT amendments going back up to four years.
It will be crucial to ensure that contracts address whether VAT is expected to be due on payments and how this should be allocated, and existing contracts should also be reviewed. More generally, this emphasises the importance of considering the inclusion of a VAT allocation clause in all contracts which contain break payments, forfeited deposits, dilapidations payments or liquidated damages payable pursuant to development agreements and agreements for lease, even where VAT is not expected to be in scope.
On 25 January 2021, HMRC issued an update stating that the new policy position set out the guidance would be implemented from “a future date” which has yet to be decided. It says that, in the interim, businesses can continue to apply the new policy or revert to applying the previous treatment of compensation payment if they wish. This is unhelpful and we hope for clarification on the position shortly. However, is appear clear that the new guidance will become policy so shouldn’t be ignored.
If your business has received or made payments in any of these circumstances in the last 4 years you should seek specific advice on the VAT status of these payments. If you need further advice, please contact us.
The information was correct at time of publishing but may now be out of date.