New policy on termination payments

March 7th 2022

HMRC is changing its policy on termination payments. As a result, some businesses will be entitled to a VAT refund while others will owe more. What’s the full story? VAT expert John Craig takes a closer look.

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.

New general policy
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 VAT’able. 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 VAT’able. To the extent they are not in this nature, they are outside the scope.

You should 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.

From 1 April 2022, VAT on termination payments count as if it were for supplies made under the contract, except for penalties or compensation. You should review the VAT treatment of such payments made since September 2020.