Philip Munn

Written by: Phil Munn and Joanne Torrens

Philip Munn

Partner

Compensation or consideration? VAT when contracts are terminated

When HMRC’s new policy on retained deposits for unfulfilled supplies came into force on 1 March 2019, we noted that there seemed to be some tension between the various European cases on the new policy. Because of this there was a suggestion that HMRC’s new policy (which means accounting for VAT on income where previously HMRC has accepted that there was no VAT due) could be challenged. HMRC’s new policy is broad-ranging, but in particular impacts on the hotel industry where booked hotel rooms are not used by the customer; and we’ve seen a case with Société Thermale d’Eugenie-les-Bains where the decision went against HMRC’s new policy

The European Court has just released another decision (Unicredit Leasing) which could affect this debate – although the subject of this decision is a finance lease agreement rather than a hotel room. 

In the latest case, the taxpayer agreed a finance lease arrangement with its client which contained a clause that said that where there was a payment default the taxpayer could terminate the agreement and demand compensation to the value of the remaining payments due under the agreement. When this happened, the taxpayer argued that this ‘compensation’ should not be subject to VAT. 

The European Court held that the termination of the contract did not change the economic reality of the contractual relationship (and therefore that the taxable amount did not change). This seems to support the basis of HMRC’s new policy (as set out in Revenue & Customs Brief 13/2018) where they state that the payment received by the supplier for goods or services:  

cannot be reclassified as a payment to compensate the supplier for a loss once it is known the customer will not use the goods or services.’

The question remains of how the new case law can be reconciled with the original decision Société Thermale d’Eugenie-les-Bains. There are differences in the fact pattern in Unicredit Leasing which could perhaps be used to distinguish this case – but this new decision from the European Court does not seem helpful in challenging the technical basis of HMRC’s new policy. 

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