Consideration: Compensation and liquidated damages that are consideration: Compensation payments: Early termination of contracts
HMRC’s policy is to treat payments arising out of early contract termination as consideration for a taxable supply. Businesses must account for VAT on these fees. This applies in cases where the original contract allows for such a termination, as well as when a separate agreement is reached.
This is supported by the CJEU decision in MEO – C295/17, which concerned the treatment of early termination fees within contracts for telecommunication services. The Court held that the fact that there is a clause in the contract requiring the customer to pay the remaining fees, means the supplier is receiving further consideration for the original supply. The fact that the customer is no longer making use of that supply is irrelevant.
The more recent case of {#}Vodafone Portugal – C-43/19 endorsed that view, even where the amount payable is not equal to the amount that would have been due had the contract been fulfilled. The court said – “Article 2(1)(c) of Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax must be interpreted as meaning that amounts received by an economic operator in the event of early termination, for reasons specific to the customer, of a services contract requiring compliance with a tie-in period in exchange for granting that customer advantageous commercial conditions, must be considered to constitute the remuneration for a supply of services for consideration, within the meaning of that provision.”.
Early termination payments are also taxable when there is no pre-existing right to terminate in the original contract. The VAT tribunal judgment in Lloyds Bank plc (LON/95/2525) supports this. Lloyds sought an early termination of a lease it held on a property., The lease did not provide for such early cancellation. Lloyds and its landlord therefore agreed a variation to the lease, setting out terms for early termination and a sum to be paid to the landlord as compensation. The tribunal found that there had been a supply by the landlord of granting and exercising an option to terminate the lease in return for Lloyds making a payment and vacating the premises.
Early upgrade fees
Early upgrade fees are a type of early termination fee and are treated in the same way.