I have a client who makes supplies to a large company.
The customer has recently written to my client to say that they have changed their terms and conditions and will deduct an early payment discount varying from 5 - 3% of the net invoice amount dependent upon when they make payment. This is a customer imposed early payment discount, not one which my client has offered. They have no choice but to suffer this discount or cease trading with the customer.
E.g. For an invoice showing a net invoice amount of £1000 and VAT £200 the customer deducts 5% of the net amount, i.e. £50, and therefore pays £950 plus the full VAT amount of £200 = £1,150.
If my client had offered this discount in the first place the VAT paid would have been calculated on the discounted amount and disclosed correctly on the invoice.
However, in the above instance how is the discount treated for VAT purposes?
My client does not know what discount will be applied, as it is dependent upon when the customer decides to pay the invoice, so the invoice cannot show the VAT on the discounted element.
Therefore is the VAT £200, despite this then being a rate in excess of 20%, and my client suffers the full cost of the fact that the customer has applied its own discount whilst HMRC doesn't lose out. Or can you treat the discount as an underpayment (or bad debt) and so calculate the VAT to be paid to HMRC as 1/6 of the total payment made, i.e. net value £958.33 and VAT £191.67.
Any advice would be most appreciated.