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VAT and prompt payment discounts: which option is best?

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We are a large corporate that offers prompt payment discounts (PPDs) to some, but not all, of our UK based clients. In addition, we periodically take advantage of the PPDs offered by our suppliers. The guidance issued by HMRC on 22 December 2014 (Revenue & Customs Brief 49/2014) explains our two options from a VAT accounting perspective, but we are struggling to determine which of these is the best fit for our business. What would you recommend?


The guidance was issued as a result of the UK VAT legislation in this area changing to bring it in line with the position in other EU member states. This is captured in VATA 1994 Sch 6 para 4. Previously, where a discount was offered (and regardless of whether it was taken up), VAT was accounted for by both the supplier and the customer on the discounted amount. With effect from 1 April 2015,  the full invoice value is booked initially, with a subsequent adjustment if and when the discount is taken up.

A business will only know whether its prompt payments discount (PPD) offer has been taken up once payment has been made, and after a tax point has been created by the issuing of the original tax invoice detailing the PPD offer. Even if payment was made just two days after the initial invoice was issued (which is highly unlikely given the current payment terms in most industries), the impact on the VAT accounting processes is the same. Consideration needs to be given to which process best suits the control framework of the business.

Accounting processes

The actual technical change to the VAT legislation is a simple one to understand: the VAT is accounted on the lower amount only if the discount is taken up. This is, in the main, a straightforward concept. However, as with many areas of VAT, particularly for larger businesses using sophisticated enterprise resource planning (ERP) systems, it is vital that the accounting impact of such changes is fully considered.

The guidance specifies two options in dealing with the discount:

  • Credit note option: The supplier can issue a credit note to the customer if the discount is taken up. The credit note would flow through the accounting systems of the supplier and customer in the usual way, the undiscounted value of the original invoice having been booked by both in the first place on their systems; or
  • Invoice statement option: The supplier can include narrative on his invoice stating that, in the event the customer takes up the discount, he must only recover the lower amount of VAT. In this option, the supplier and customer are to downwardly adjust the amount of VAT they originally booked in their systems without any further documentation changing hands between them. Instead, both parties are to retain evidence of the actual value paid (via bank statements).

There will typically be two key factors to consider in respect of the VAT accounting processes referred to above: tax risk; and the question of whether accounts receivable (AR) and accounts payable (AP) processing is negatively impacted.

Credit note option

This option appears ‘cleanest’ from a tax risk perspective, providing an immediately traceable audit trail in the form of the credit note, a key accounting document. In addition, ERP and other accounting systems have built-in risk management and control functionality, which relies on having documentation to support adjustments.

On the downside, however, for a business using PPDs regularly, this could effectively double the AR and AP process in terms of volume, with two documents rather than one for each sale/purchase involving a PPD. For many AR/AP teams, this could have a serious impact on processing times, requiring more staff or slowing down processes.

In addition, there could be a need to recognise the difference between a normal commercial credit note scenario and a PPD credit note scenario, the former arising from a commercial dispute and the latter simply being a standard VAT process.

Invoice statement option

The potential difficulty with this proposal from a tax risk perspective is that it creates the requirement for an audit trail to be based on something other than a primary accounting document (invoice or credit note).

The suggestion is that the bank statement is used to evidence the value of the actual payment made. To the extent that there is no direct match in values – for example, because the customer has made a single payment relating to several invoices, some where he takes up the PPD and others where he does not – the audit trail could be difficult to identify and this could create tax risk. From a process perspective, there is no doubling up on the documentation being issued, but the requirement to evidence the final value of the transactions means that a control will need to be created to support what will effectively be a manual process to downwardly adjust the value of the original invoice.

Manual adjustments necessarily result in increased processes and the type of controls in the ERP system will differ for each business. As mentioned above, most systems will not allow an adjustment without a document reference. This means that, although this solution would appear to result in fewer documents than the credit note option, in practice the system may require a dummy credit note or similar to evidence the adjustment, meaning the processes could end up being more onerous than in the first option.

Where does this leave us?

There is no obvious answer to the question posed. The only clear point is the absolute need for the AR and AP teams to be heavily involved in determining the way in which the business will implement the new legislation.