Share this content

VAT when customer imposes their own early payment discount

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.


Please login or register to join the discussion.

29th Jan 2013 12:16

If they go along with it

then the VATable amount is the LEAST that the customer could pay (Net) if they take the maximum discount.  If they fail to so do it makes no difference to the VAT retrospectively.

Thanks (1)
29th Jan 2013 12:21


I always think of VAT on discounts as accelerated bad debt relief.

In the case of the initial case where the customer insists on the discount, by the letter of the law are they not underpaying a debt they owe?  If irrecoverable this will be bad debt and relief under the bad debt relief for VAT.

In the case of other amounts, where not instigated by the supplier I'd argue same treatment.

However, better would be to approach it as on negotiation with the customer the supplier has agreed to a discount rate.  Apply the discount to the invoices based on what the customer is insisting upon and treat it as a normal discount.  There is nothing I'm aware of to stop negotiation in this regard.  By continuing to supply the customer the supplier is de facto agreeing to the new terms really?

Thanks (1)
29th Jan 2013 12:36

By the way!

I have come across this sort of thing in the past.  It's usually a try-on and if challenged in an educated manner the customer will usually back down.

A strongly worded but polite letter along the lines of 'Our prices are already as competative as we can make them, etc.' and 'the amount of discount that you are requesting (NOTE!) is out of all proportion, when calculated annually to current lending rates' will usually do the trick.

Thanks (1)
29th Jan 2013 12:44

Discounted discounts

From my limited knowledge, early payment discounts are usually applied to a figure that is marked up to penalise late-payers.

Hence your client should make his own pre-emptive 'correction' to the cost quoted to his customer.

Standard cost:

Early payment cost:

And also check up on the current government business spiel on late payment, so as to be using the correct 'terminology'.

By clearly marking the cost as 'early payment discounted' then the customer cannot blithely apply his own discount on top of the already discounted price.

Thanks (1)
29th Jan 2013 16:02


I am interested in what input tax the customer is claiming.  Should be the same as the output tax declared if the VAT system makes any sense.

I think this tactic is common in some David vs Goliath situations and it may be a commercial decision as to whether it is acceptable.  It would be possible for the customer to issue a debit note and reduce the VAT declared by both parties but i suspect they are trying to have their cake and eat it, so to speak.

One possible way to address this is to send a credit note to reflect the adjustments.  Nothing extra will be due from the customer end, but there would be no bad debt and of course the output VAT could be reduced.

A credit note is to reflect a genuine agreed credit.  It seems to me that if the supplier does not challenge the credits, he has accepted them, and so can issue a document to reduce his output VAT.

Good luck!

Thanks (1)
29th Jan 2013 19:18

If the customer is going to impose 'his' early settlement terms you should just calculate the VAT based on him taking the max 5% discount. In this instance your client accounts for VAT on 95% of the price and the customer remits whatever is deemed the discounted amount plus the VAT charged on the invoice.

Thanks (1)
29th Jan 2013 20:03

customer decides discount

I am not sure that applying the usual early settlement rules works if the discount is not offered and shown on the invoice.

My opinion is that a credit note is needed to balance up the invoice with the payments.

I suppose, if you both agree, you could do this without adjusting the VAT.

Thanks (1)
29th Jan 2013 20:13


If any of your goods or services are discounted, you charge VAT on the discounted price rather than the full price. 

So if the customer says he is taking 5% and does then you are accepting it and above applies 

Thanks (1)
29th Jan 2013 20:29

Sorry to be pedantic...
But it seems to me none of the products are discounted until the customer decides to reduce the consideration, on a variable basis. My understanding of discounts is that they are offered, pre sale, or agreed post sale and the basis for adjusting these supplies is different in each case.

My worry is that HMRC may insist on the output tax on the invoice being paid over - after all this balances with the purchase VAT. Any solution that leaves the input tax and output tax different is, in my opinion, risky.

Thanks (1)
29th Jan 2013 21:08

If the customer has told you he is taing 5% on all invoices and you don't disagree then it is agreed. By adopting settlement discount HMRC don't lose out as the VAT charged is on the discounted amount and the customer can't take a different Input tax deduction than shown on the invoice - hence why VAT calculated on discounted amount regardless of whether customer takes the discount or not!!

Thanks (1)
29th Jan 2013 21:16


Nothing more to add, other than to say, whatever you do, make the output and input VAT the same, then HMRC can't lose out. I would also recommend informing HMRC of whatever policy you adopt as the VAT sums can get significant.  I had a case once with belated discounts being given where the VAT involved was over £500k and HMRC did not agree with the policy adopted.

Thanks (1)