HMRC has confirmed a new policy that VAT remains due on a deposit, even if the customer does not use the goods or services for which it was paid. This comes into force with effect from 1 March 2019, cancelling HMRC’s previous interpretation which allowed some non-refundable deposits to be treated as VAT free compensation.
This change will primarily affect the hospitality industry, which will soon be unable to recover VAT charged on cancellation or ‘no show’ charges, eg for hotel room bookings, but any business that retains forfeited deposits for unfulfilled supplies may also be covered by the new policy.
HMRC’s previous approach to deposits
HMRC previously allowed businesses to claw back VAT accounted for on deposits where the customer, in the end, did not use the service or collect the goods for which payment had been made.
That policy was largely based on the 2007 judgment of the Court of Justice of the European Union (CJEU) in Société thermale d'Eugénie-les-Bains, which ruled that deposits kept by a hotel for cancelled bookings had no direct connection with the supply of any service, so should be regarded as compensation for the loss suffered as a result of the cancellation. Since then, HMRC’s guidance has stated that a cancellation charge for a hotel room is outside the scope of VAT (unless it is for a ‘guaranteed reservation’, where the hotel is contractually obliged to retain an empty room for a customer who can arrive at any point within the guaranteed period).
HMRC’s new policy
In the 2018 Budget, HMRC announced that changes will be made to the VAT treatment of deposits, with details to follow before the end of the year. HMRC has now published Revenue and Customs Brief 13 (2018), setting out its new policy.
HMRC has concluded that, when a customer makes or commits to make a payment, it is consideration for a supply and therefore subject to VAT. HMRC says it cannot be reclassified as a payment to compensate the supplier for a loss once it is known the customer will not use the goods or services. HMRC’s new policy is therefore that VAT is due on all retained payments for unused services and uncollected goods. VAT already accounted for on the deposit must not be reduced, unless the payment is refunded. Only fully refundable deposits paid as security are outside the scope of VAT.
HMRC’s new policy is based on more recent judgments of the CJEU, including in Air France/KLM, where it was found that VAT must be accounted for on an unused airline ticket because the customer had purchased the right to use the service, not the service itself. However, this does not take account of the ruling in Société thermale d'Eugénie-les-Bains which specifically found that that deposits kept by a hotel for cancelled bookings could be regarded as VAT free compensation.
HMRC also says that it will not accept repayment claims for past VAT periods from those who have not recovered VAT paid on these deposits under the old rules. HMRC seems to believe its new policy was always the correct approach and its prospective start date of 1 March 2019 is simply to give businesses time to change their VAT accounting procedures. Nevertheless, this creates a disparity as some businesses will have effectively enjoyed a windfall in past VAT periods where others have not.
The CJEU currently has the final word over interpretation of VAT law, and HMRC has not yet explained its logic for applying the Air France/KLM judgment to all deposits while ignoring Société thermale d'Eugénie-les-Bains. As it is expected that CJEU case law will continue to have precedent status in the UK after Brexit (unless and until the government specifically changes the UK law on that point), it is therefore possible that any refusal of VAT recovery on a cancellation charge for a hotel room by HMRC may be challenged in the courts.
Operators in the hotels, restaurant and leisure sectors, or any other business that charges non-refundable deposits should take action now to prepare for this change and, if necessary, protect their position, by:
- Reviewing their current VAT treatment of deposits and checking their terms and conditions on cancellations/no shows to determine whether they will be affected by HMRC’s new policy;
- Preparing to change their VAT accounting procedures from 1 March 2019;
- Identifying any retained deposits that could, arguably, be regarded as compensation under the Societe Thermale Eugenie Les Bains case (e.g. hotel room payments other than for a guaranteed reservation) and consider asking HMRC to confirm its view on those precise circumstances.
For more information on this issue, please get in touch with your usual BDO contact, or one of our VAT specialists shown above.