Dangle Hearth for Revised Steering on Adjustments to VAT and Early Termination Funds

Hang Fire for Revised Guidance on Changes to VAT and Early Termination Payments

This blog is a continuation of our recent blogs on the controversial changes to VAT and early termination payments by HMRC, as well as VAT on intellectual property settlement compensation. As noted earlier, the retrospective nature of the changes and the resulting risk of voiding historical settlement payments raised a number of questions. This has now led to HRMC’s plans to issue further guidance on the matter.


In September 2020 the UK Treasury Department approved HM Revenue & Customs (“HMRC“) Updated its guidelines on VAT treatment of contractual compensation payments for early termination of commercial contracts.

In the guidelines, underpinned by HMRC’s interpretation of EU case law, termination payments (including for breach or withdrawal or under flat-rate compensation clauses) were treated as consideration for supplies for VAT purposes. The result of such treatment is that VAT may be charged depending on the nature of the underlying delivery. This set off alarm bells as severance payments had previously been treated as being outside the scope of VAT. According to the new rules, the parties must distinguish between:

  • On the one hand: pure compensation payments that may not fall within the scope of VAT; and
  • On the other hand: payments that represent a consideration for VAT, e.g. B. for a change or early termination of a contract.

However, it was the retrospective nature of the changes that was really problematic, given the ability for HMRC to revisit historic settlements over a four-year period.

Where we are now

At the end of January 2021, the HMRC further updated its guidelines (see here). It appears that HMRC has listened to the feedback from the business community – it has decided to apply the updated VAT treatment set out in its guidelines only prospectively, rather than the previously proposed retrospective application.

Next Steps

This is, of course, a welcome temporary halt to the proposed changes outlined in the revised guidelines. The HMRC will be issuing revised guidelines and a new Revenue and Customs Letter to explain what companies need to do shortly. This includes guidance on what to do if companies have already changed how they handle such payments as a result of HMRC’s previous announcement.

Until the new guidelines are published, companies can either:

  • continue to treat such payments as further consideration for the contractually agreed delivery; or
  • Go back to treating them as out of VAT scope if they were treated that way before HMRC changed the rules.

Contact Carlton Daniel, Partner, and Tim Jarvis, Partner for assistance with creating IP licenses or assessing whether sales tax may be charged upon termination or in connection with IP violations.

Blog with the support of budding lawyers Sera Kaplan and Sarah Roughton.

Copyright 2021 Squire Patton Boggs