Consideration

HMRC’s VAT manual at VATSC05100 gives a clear definition of the phrase “consideration”, namely that it is “a payment for the supply of goods or services”. The consideration that you receive in your business will usually be in a monetary format but you might also receive non-monetary consideration. You must still declare output tax if you receive non-monetary consideration, based on its open market value. This is because VAT is payable on both monetary and non-monetary consideration.

Example. Jean is VAT registered and cleans the windows at her local golf club in return for free playing membership. If she had to pay for her membership, it would be £1,000 per year, so this is the non-monetary consideration received for her cleaning services. It would be sensible for both the club and Jean to issue separate sales invoices for their supplies, even though no money will be exchanged.

If your business uses the cash accounting scheme, you will declare output tax on the return that includes the date when you received the benefit of your non-monetary consideration.

Compensation

A key issue with “consideration” is that there is usually a direct link between a payment and a supply. A compensation payment is completely different and usually has the following features:

• the amount you receive does not relate to a specific supply of goods or services where a payment could be regarded as a credit reduction against a sale, i.e. where output tax would be reduced
• the economic reality is that the price of a supply is not being adjusted and your supplier is therefore contractually paying “liquidated damages” to compensate you for “the actual loss suffered as a result of the breach”.

Compensation payments are outside the scope of VAT.

Early termination fees

If a contract is terminated early, the termination fee paid by your customer will be subject to VAT if the payments within the contract are subject to VAT. This was confirmed in 2022 following two Court of Justice of the European Union cases about mobile phone contracts terminated early.

Example. A cleaning business has been compensated by a customer in return for the early termination of a contract. It must charge 20% VAT on the termination payment it receives.

If you receive a non-refundable deposit from a customer for a future supply of services, and you retain the deposit if the customer cancels, this deposit will be subject to VAT even though the customer has not received any services.

Damage payment?

The damages payment received from your supplier is outside the scope of VAT because it relates to a breach of contract rather than any supply of goods or services. You must not issue an invoice to the supplier or charge VAT. You will also exclude the compensation payment from Box 6 of your VAT return, the outputs box, because it is not linked to any goods or services you have supplied.