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Brief 2/2022: oops, HMRC did it again

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In September 2020, Revenue & Customs Brief 12/2020 suddenly announced that the VAT treatment of both early termination payments and other contractual compensation payments was changing. 

Not only did Brief 12/20 go way beyond the ambit of the dicta in the cases of MEO (Case C-295/17) and Vodafone Portugal (Case C-43/19), it was confusingly simplistic, and implied that all such payments were standard rated – even those where the underlying contract was exempt, or where the payment was by a supplier to its customer. 

In January 2021, HMRC partially retracted Brief 12/2020, and from there the market split into three camps:

  1. those treating such payments as still outside the scope of VAT under the old law;
  2. those applying the new law literally as set out in Brief 12/2020 (so applying standard rate VAT to all such payments automatically); and
  3. those who thought such payments should follow the underlying contract (so exempt, zero or standard rated).

After 17 months of lobbying, discussion, and consultation with counsel, we now have Brief 2/2022. The revised guidance is not what was hoped.

A few areas they have fixed. It is now clear that:

  • HMRC intends for customer termination payments to fall within the VAT regime and follow the underlying contract (for example, so are exempt, if the underlying supply was exempt);
  • when it is the supplier making the termination payment, it is not plus 20% VAT; and
  • dilapidations remain outside the scope.

However, much remains confused. 

If intra-contract termination payments follow the VAT treatment of the underlying supply (whether standard rated, zero rated or exempt), do termination payments outside the contract follow suit, or are they always standard rated as a separate supply of the right to terminate? It is unclear.

What about other contractual payments like late paid interest? Despite much asking, HMRC is silent on this.

What about compensation payments from a supplier to their customer? If we apply Vodafone Portugal to such scenarios, it follows the underlying contract – which would make it a refund (plus VAT credit note etc). And you’d only fall outside that if you are in consequential loss or other compensatory territory beyond the services originally rendered, or where the payee isn’t your customer. 

HMRC implies this but it is woefully unclear in the penultimate paragraph of its guidance in the VAT Supply and Consideration Manual at VATSC05930. That paragraph simply does not make sense. If ‘liquidated damages’ is something you’re paying pursuant to contract (usually a contractual pre-estimate of loss to save on costly disputes around quantum), then it should follow the contract (VAT refund) not fall outside scope, i.e. liquidated damages is the very circumstance that should be a refund. Does HMRC mean you can choose which treatment to apply? Certain sectors will be delighted if so. But I doubt it.

And spare a thought for anyone in category 2 above, faithfully applying Brief 12/2020 and charging ‘VAT’ that wasn’t in fact properly chargeable. It seems they have to unpick it all, and try to get a refund without any assurances that HMRC won’t trot out ‘unjust enrichment’ grounds to prevent a repayment!