HMRC U-turns on contract termination fees

HMRC’s sudden change in VAT policy in Brief 12/2020 had retrospective effects and contradicted existing HMRC guidance. The policy has now been reversed.


HMRC announced a major chance of policy for the VAT treatment of termination fees and compensation payments on 2 September 2020, in Brief 12/2020, but it has now reversed that change and confirmed that the policy will be introduced “from a future date.”

First policy change

The key outcome of this policy change was that most termination fees and cancellation payments were deemed by HMRC to be VATable if they related to standard rated contracts, such as the fees paid by mobile phone users to cancel their contracts early. Those charges were previously accepted by everyone in the tax world as being outside the scope of VAT (no supply of goods or services), including in the guidance published in HMRC’s internal VAT manuals.

Unfair to be retrospective

HMRC stated that the policy change was to be retrospective. It expected businesses to go back four years and account for output tax on past fees. However, the latest announcement on 24 January 2021 has completely reversed the September version of Brief 12/2020, confirming that the new rules will be introduced in the future, ie no retrospective adjustments are needed.

In the introduction to the updated Brief 12/2020 HMRC says: “Revised guidance and a new HMRC Brief to explain what businesses need to do, will be issued shortly.”

Two choices

It would be an onerous task to go back five months to refund overcharged VAT to all customers – there might be a lot of them. This is not necessary, and the Brief 12/2020 confirms that a business can carry on treating cancellation fees as VATable.

But the business can also refund past VAT charged to customers if its previous policy (before 2 September 2020) was to treat such cancellation payments as outside the scope of VAT.

The choice here is straightforward: if your customers can claim input tax, there is no benefit in adjusting the VAT that has been charged. However, if the customers are private individuals, exempt or partly exempt businesses, or non-business organisations, a VAT credit will be welcome.

Unfair behaviour

It is noted that HMRC did not seem concerned that the retrospective change of policy contradicted the guidance given in its own internal manuals. When the Brief 12/2020 was issued, the department hastily withdrew the previous guidance and replaced it with the new interpretation.

Accountants and advisers frequently use these manuals to check HMRC’s interpretation of the legislation on key issues. The manuals include more detail and analysis than the VAT public notices, often supported by important case law.