Andrew Needham highlights changes to the VAT treatment of prompt payment discounts, and considers how this affects businesses.
Prompt payment discounts
HMRC has special ‘valuation’ rules relating to the VAT treatment of prompt payment discounts (PPDs), and businesses have been allowed to calculate the VAT on the discounted amount. For example, you sell £100 worth of goods to a customer and offer a 10% discount if he pays within 30 days. This is how you calculate the VAT:
Value of the goods if the discount is taken: £100 – 10% = £90
VAT due: £90 x 20% = £18.00
The sales invoice will show a goods value of £100, a PPD of 10% and VAT due of £18.00.
If the customer pays within 30 days all the figures balance, but even if the PPD was not taken up the VAT charged would not be amended.
Aggressive tax planning
This system ran perfectly well from pretty much the start of VAT, but some businesses saw the opportunity to use the PPD rules for aggressive VAT planning.
Example - PPD planning arrangement
A business could offer a PPD of 99% to a customer who cannot recover its VAT, on the understanding that it will not be taken up.
That would reduce the customer’s non-recoverable VAT nicely whilst still giving the supplier the same income.
HMRC changes the law
Historically, PPDs have mainly been offered on business to business (B2B) supplies, and recipients have generally been entitled to recover any VAT charged.
HMRC has found that PPDs are increasingly being offered to final consumers (B2C) or businesses that are not registered for VAT and cannot recover the VAT they are charged. In particular, HMRC has identified several instances of suppliers of B2C services offering PPDs in the telecommunication and broadcasting sectors. Under the existing interpretation, this results in a tax loss to HMRC where PPDs are not taken up.
HMRC says that the change announced in the budget will ‘protect the revenue’ by putting it beyond doubt that UK VAT legislation on PDP’s is aligned with EU VAT legislation, and ensuring that VAT is accounted for on the full consideration actually paid.
When do the changes come in?
This measure comes into force for supplies of telecommunication and broadcasting services ‘where there is no obligation to provide a VAT invoice’ made on and after 1 May 2014; this means to customers who are not VAT registered. For all other supplies, the measure will have effect for supplies made on and after 1 April 2015, including all B2B supplies.
Administrative nightmare!
Clearly, HMRC has identified a tax loss and the potential for future increasing losses, but the problem lies in the administrative difficulties for businesses in accounting for the changes. Currently, a business issues an invoice showing the VAT on the discounted amount and if the discount is not taken up he need do nothing and simply accounts for the VAT on the discounted amount.
Following these charges, a business will have to decide if it is going to issue an invoice showing the VAT on the full amount or the discounted amount. Then it will need to monitor the payment of the invoice and if it is paid within the discount terms, issue a credit note if it charged VAT on the full amount; or if the payment is late, issue a supplementary invoice for VAT only if it charged VAT on the discounted amount! Most businesses are likely to charge VAT on the full amount, as it may be difficult to recover any unpaid VAT.
Practical Tip:
If you provide contingent discounts you will need to change your accounting system by 1 April 2015 at the latest, in order to account for VAT on the amount actually paid.
