This article briefly comments on HMRC’s updated policy related to the VAT treatment of damages payments and how this might impact compensation payments under the Commercial Agents Regulations following the termination of a commercial agency.
For more information on the updated policy, see Revenue & Customs Brief 12/2020.
Introduction
Prior to the updated policy, most damages payments, including compensation and indemnity under the Regulations, were generally treated as being outside of the scope of VAT.
For agency contracts, that meant that compensation payments were generally not treated as payments for the supply of services subject to VAT. That approach seemed to align with the methodology used for calculating compensation payments (under Londsdale v Howard & Hallam Ltd) namely, a payment based on the sale of the agency business to a hypothetical purchaser which would not normally attract VAT.
What Has Changed?
The new guidance from HMRC states that where there is a direct link between the damages payment and an underlying supply of goods or services to which the contract relates, such payment is within the scope of VAT.
How Does the New Guidance Apply to Commercial Agency Contracts?
A commercial agency contract is a contract for the supply of services by an agent to its principal. In most circumstances, this involves a taxable supply, subject to VAT.
Therefore, if an agent receives payment for compensation or indemnity under the Regulations by a principal, that agent may well have to account for VAT on that payment since it relates to an underlying taxable supply of services.
Potential Effect on Commercial Agency Claims Going Forward
The updated guidance demands a greater awareness by agents, principals, and litigators of the possible tax treatment of termination payments under the Regulations. It is possible that we may see agents starting to claim an additional 20% on damages to account for any shortfall after accounting to the HMRC for VAT.
As specialists in commercial agency law, we have seen an increase in attention to VAT issues, including whether or not the agent is VAT registered and whether a VAT invoice should be raised upon settlement where that involves a termination payment under Regulation 17.
It is now more important than ever that agents and principals seek advice from an accountant or a tax specialist regarding the likely tax treatment of any damages payments before agreeing on terms of the settlement.
Here to Help
Our team of expert Commercial Litigation Solicitors are ready to assist in all aspects of Commercial Agency Law. We are always happy to have an initial no-obligation chat to help guide you in the right direction. Please do not hesitate to contact us on 0161 941 4000, or you can email the Commercial Litigation Team.