VAT on termination sums and liquidated damages: HMRC guidance update

On 2 September 2020 HMRC published a briefing note – RCB 12/20 – altering its long-held position that VAT was not chargeable on termination sums and liquidated damages calculations. The change followed two recent Court of Justice of the European Union cases – Meo (C-295/17) and Vodafone Portugal (C-43/19).

Historically, HMRC’s view was that VAT should be charged on arrears but not on the future rentals element of termination sum and liquidated damages calculations (although leasing companies were able to charge VAT if they wished pursuant to an agreement with HMRC).

HMRC’s updated guidance confirmed that the entirety of both termination sums and liquidated damages calculations constitute taxable supplies to VAT, and stated that “any taxable person that has failed to account for VAT to HMRC on such fees should correct the error”.

In the absence of any additional guidance as to the retrospective nature (or otherwise) of HMRC’s updated guidance, where an error has been made in the treatment of VAT firms must look back four years, submit an error correction and pay the VAT to HMRC.

Updated guidance

Following an intervention from the Finance & Leasing Association (FLA), HMRC have confirmed that they will not be applying VAT retrospectively on termination fees and liquidated damages payments. 

HMRC have further confirmed to the FLA that RCB12/20 will be withdrawn and, a revised Briefing Note will be published. The FLA have been informed that HMRC’s new approach to VAT will take effect from 1 February 2021.

Relevant agreements

HMRC’s guidance – both the existing RCB 12/20 and draft guidance provided to the FLA - does not explicitly, or implicitly, exclude termination sums due under hire purchase agreements. However, given that the VAT element of hire purchase agreements is paid upfront by the lessee, it is unlikely that VAT will need to be applied to the terminations sums due under such agreements. 

HMRC’s likely revised guidance is aimed at applying VAT only to compensation which equates to the sums that would have been a VAT-able supply under the agreement (i.e. lease rentals which would have attracted VAT had the agreement not terminated). That is not the case with hire purchase agreements.