Change in policy for VAT on termination payments

Changing policies

In September 2020 HMRC changed its policy on one-off payments made in connection with a contract, e.g. early termination charges. The change was heavily criticised so in January 2021 HMRC suspended it but said businesses could follow it if they wished. It has now decided to revert, in part, to its pre-2020 policy from 1 April 2022.

A termination or additional payment that broadly puts the parties in a similar financial position as if the contract had continued follows the VAT treatment as payments under the contract. Generally, other payments such as a penalty charge or compensation are outside the scope of VAT.

Payments made to landlords. Dilapidation payments ensure that landlords are not out of pocket if the property is not in the state it was when the lease commenced. The new rule is that such payments are outside the scope of VAT.

Parking fines . The new rule is that the VAT treatment depends on the nature of the charge. If it’s an additional charge for using a space beyond the time originally paid for, it’s VATable. But where it’s a punitive charge, that is, designed to deter overstaying, it’s outside the scope.

Liquidated damages. These are agreed payments that allow for early termination, say, for a mobile phone contract. The new general policy applies if the payment is intended to cover the supplier’s costs or basic payments due under the contract they are VATable. To the extent they are not in this nature, they are outside the scope. 

Refer to the new HMRC guidance and then review the VAT treatment of termination payments, fines, etc. since September 2020. Corrections for over or underpaid VAT should be made in the usual way.