Coronavirus (COVID-19)—what are the potential VAT consequences of cancelling or aborting contracts due to coronavirus?

Coronavirus (COVID-19)—what are the potential VAT consequences of cancelling or aborting contracts due to coronavirus?

Produced in partnership with Jo Crookshank and Bryn Reynolds of Simmons & Simmons LLP

Government recommendations on social distancing, self-isolation in the case of sickness, and business closures has resulted in many typical business and social activities being postponed or cancelled altogether by both customers and suppliers.

Where a contract is cancelled, any supplies from a VAT perspective will no longer take place, requiring (depending on the terms of the particular contract) a refund of any payments and the cancellation of invoices or credit notes as appropriate. For more information on how a taxable person who has accounted for and paid VAT on a supply, but who is not ultimately paid for that supply, may claim a refund of the whole or part of the VAT they have already accounted for, see Practice Note: VAT bad debt relief.

Where payment for an anticipated supply has been made but the customer no longer takes up the anticipated services, it is possible that the correct analysis is that the supplier has actually complied with the contract and made the anticipated supplies, simply by holding out the opportunity of the services to the customer. HMRC’s position on unfulfilled supplies and retained payments was set out in Business Brief 13/2018. In this case, output VAT will still be due on the supply based on HMRC’s guidance although the government has suspended any VAT due from 20 March until 30 June 2020 and is allowing VAT-registered UK businesses until 31 March 2021 to pay any liabilities that have accumulated during that period (see: COVID-19: support for businesses—support for businesses through deferring VATVAT payments on account and Deferral of VAT payments due to coronavirus).

Payments by a supplier to the customer, where the supplier is no longer able to perform the contract, are likely to be viewed as compensation payments and outside the scope of VAT. This is equally true where the amounts are specified in the contract as liquidated damages. Careful consideration of the particular contractual arrangements and any termination agreement are required to determine the true nature of any payments made from a VAT perspective. For more information, see Practice Note: VAT treatment of damages and compensation payments.

Some businesses may choose to make goodwill gestures to their customers even where contracts are legitimately rendered unenforceable. Care needs to be taken that VAT is correctly accounted for. For example, any business goods given away would need to be accounted for as a deemed supply, unless they are under the threshold and meet the requirements for small gifts.

Any input VAT incurred on aborted transactions would, generally, be attributable to the anticipated supplies even if those supplies do not take place.

From a direct tax standpoint, costs incurred on aborted business transactions should remain deductible business expenses.

Where third party business transactions are aborted, this may have a direct or indirect consequence on the intragroup arrangements and associated transfer pricing issues. For example, a termination cost may be incurred, or compensation payment may be received which will need to be allocated among group entities in accordance with functional and risk profiles determined by the transfer pricing model.

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