Compensation payments have normally been treated as outside the scope of VAT. However, recent consideration of compensation payments by the UK courts and the Court of Justice of the European Union (CJEU) has resulted in such payments being liable to VAT.

New HMRC guidance on charges described as compensation or early termination fees in a contract have been changed to reflect this recent position adopted by the courts and makes it clear that these payments are generally liable for VAT. The change was published by HMRC’s Business Brief 12/20 (2/9/2020).

Controversially, HMRC advises that any VAT-liable person who has failed to account to the tax authority for VAT on such fees must now correct their error as soon as possible. This makes this change retrospective and places a compliance burden on lawyers.