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VAT on cancellation fees

I am looking for clarification on the VAT treatment of charges for cancellation of a contract

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I am looking for clarification on the VAT treatment of charges for cancellation of a contract.  I understand that HMRC have changed their policy on VAT and payments for unfulfilled supplies from 1 March 2019, as set out in Revenue and Customs Brief 13 (2018).  The Brief outlines that from 1 March 2019 HMRC policy will be that VAT is due on all retained payments for unused services and uncollected goods.

Where a business sells tickets for an event but, under its T&Cs, it allows the customer to cancel and receive a refund, less a cancellation charge.  Is the cancellation charge now subject to VAT under this new policy?

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By paul.benny
21st May 2019 10:38

The VAT Brief says

“If the supply does not take place, the VAT must not be reduced, unless the payment is refunded. ... It 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.”

Here we are dealing with a full refund less a fee and clearly the refund includes a refund of output tax. There are two ways of looking the cancellation fee:
1) There is a second supply of administrative services, with VAT due; or
2) The cancellation fee remains an out-of-scope compensation for loss.

Which applies probably depends on the facts of the case – for example a £10-20 flat rate fee looks more like an administrative charge.

Doubtless there will be tribunal cases to clarify interpretation. In the meantime, do you want to take the risk of treating cancellation fees as out of scope and potentially being one of those test cases?

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Replying to paul.benny:
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By breakaway.barry
21st May 2019 11:12

I agree that thare are two ways of looking the cancellation fee:
1) There is a second supply of administrative services, with VAT due; or
2) The cancellation fee remains an out-of-scope compensation for loss.
In this particular case the client's T&Cs state "Providing you give more than 7 days’ notice (includes weekends and bank holidays) you will receive a full refund as a Credit Note, less a Cancellation Fee of 20% of the cost of the event".
As you have said, the treatment of the cancellation fee is open to interpretation. Is it possible that changing the wording of the T&C's to state that the deduction is a compensation for loss would put it out of scope?

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Replying to breakaway.barry:
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By Vile Nortin Naipaan
21st May 2019 13:52

No. On a proper analysis, you end up with the same amount of VAT.

Let's say you're charging somebody £120 (VAT-inclusive) for goods or services, X. They can cancel but you get to keep all the money. Historically, HMRC took the view that there was no supply, so the £120 was outside the scope.

That view is incorrect, because whilst nothing was given in return, the £120 was paid as a consideration (for nothing as it turned out). VATA 1994 says that there is a supply of goods if there is a supply of goods and there is a supply of services if anything is done for a consideration and it is not a supply of goods. On a venn diagram, the doing nothing circle would fall wholly within the doing anything circle, and so doing nothing for a consideration is a supply of services.

Going back to the £120, if the customer can cancel, but will only receive 80% back, then that is an adjustment to the consideration for the doing nothing service, and VAT is due on the 20% retained. IMHO.

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Replying to breakaway.barry:
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By paul.benny
22nd May 2019 09:08

Wording alone is unlikely to be enough to justify the cancellation charge as compensation for loss.

The rationale for treating a cancellation charge as out of scope was that the charge is liquidated damages - ie an estimate of the loss suffered by the seller as a result of the buyer's cancellation.

Can your client's cancellation fee can be justified by reference to their losses? For example if you order a custom-made item, the seller may want a non-refundable deposit that covers the cost of materials.

If the cancellation fee can be objectively justified - for example it's your client's fee the average margin on his events, then go for it.

As with any judgement, I would document the rationale fully at the time, ensure that there are proper supporting calculations which are periodically reviewed and updated. It's usually easier to defend a position if you can show it was properly arrived at rather than trying to create a post hoc justification.

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