On 2 September 2020, HMRC announced in Revenue & Customs Brief 12/2020 that it now interprets two EU cases to set a new general rule that UK VAT is payable on early contract termination and cancellation fees, which HMRC extends to compensation payments. The EU cases are MEO (C 295/17) and Vodafone Portugal (C 43/19).

In January 2021 HMRC announced that this change of practice would not be implemented until a future date, but an updated Brief has now been issued, confirming that the change is now to take effect.

This reverses a long-running position whereby it could be presumed that most compensation payments were outside the scope of VAT (which was on the basis that no supply was taking place). The basic position now is that most compensation payments are VAT-able, unless an exception applies.

HMRC anticipates exceptions “only where there is no direct link between a payment and a supply of goods or services”.


All businesses must adopt the revised treatment no later than 1 April 2022. This includes any taxable person that has had a specific ruling from HMRC saying that such fees are outside the scope of VAT.

Businesses that adopted the revised treatment for payments that are further consideration for supplies should continue to treat these supplies in accordance with the revised policy.

Any business that adopted the treatment outlined in the guidance published in September 2020 and accounted for VAT on transactions which under the latest guidance are outside the scope of VAT may correct this in the normal way, for which guidance is available here.

Supplier default

However, where the supplier is the defaulting party and paying a customer, HMRC has not yet confirmed any revision to its view of the historic position, but payments made by the supplier will usually not be consideration for a supply. Such payments should therefore, depending on the circumstances, be either:

  • compensation which will remain out of the scope of VAT, or
  • a repayment of some of the price paid by the customer (necessitating the issue of a VAT credit note),

notwithstanding HMRC’s change in practice.