Compensating For Past Errors – HMRC's Retrospective Change In Approach To VAT On Compensation

Last month HMRC announced in a Business Brief (12/20) a change in its view of the VAT treatment of certain compensation payments relating to the termination of contracts pursuant to recent case law at EU level. Previously, HMRC's view of the law was generally that compensation payments paid on the termination of an agreement were outside the scope of VAT.

The new guidance – which updates HMRC's Manual – makes it clear that certain payments made on the termination of contracts, which previously would have been viewed as compensation, should instead be subject to VAT. In addition, the new guidance can be read as applying more broadly and at face value applies to many types of compensation payments and damages.  Clarification is being sought from HMRC as to whether the changes are actually intended to be that broad, as the case law giving rise to the change in approach by HMRC seems to apply more narrowly. We comment further on certain types of payment below.