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VAT rules for customer discounts 2015

20/04/2017

From 2015 there will be a new way to calculate VAT where you offer certain types of discount to your customers. What steps must you take to prepare your invoicing procedures for the change?

The VAT value of supplies

For almost as long as VAT has been around the rules have allowed businesses that offer their customers a lower bill if they pay quickly to make a corresponding reduction in VAT. This is known as a prompt payment discount.

Example. You invoice a customer for £1,000 plus 20% standard rate VAT making the total bill £1,200. To encourage them to pay on time you offer a 5% discount if they pay within 14 days. The VAT can be reduced by the same percentage. However, the neat trick is that the discount applies to VAT even if the customer doesn’t pay within 14 days.

Unfair tax avoidance

In recent years some less scrupulous businesses have found a way to use the prompt payment discount rules to give themselves an advantage over their competitors.

Example. A business offers a discount of 75% if the customer pays their bill within five days. But first the seller and the buyer come to an agreement that the latter won’t make use of the discount. However, because of the way the rules work the VAT payable is still based on the discounted amount. The saving on a bill of £1,000, excluding VAT, would be £150, i.e. £200 VAT x 75%.

Advantages

The advantage of the scheme for most customers that are VAT registered is merely cash flow, as they can reclaim VAT paid on purchases anyway. Therefore, it doesn’t matter to them how much VAT they are charged. However, for unregistered customers or those who are VAT exempt or partially exempt there’s a real saving. So those types of customer are likely to buy from a seller who offers artificially large prompt payment discounts. The main culprits were businesses supplying telecommunication and broadcasting services. The trouble is that to play safe the government is changing the rules to end VAT advantages for prompt payment discounts in all types of business.

Telecommunication businesses

The new rules have been targeted at the telecommunication and broadcasting market first. Since 1 May 2014 VAT cannot be reduced by prompt payment discounts. For supplies made by all businesses to all types of customer, the new rules will apply to goods and services supplied on and after 1 April 2015.

Other businesses

Current position. Until the new rules come into force, if your business issues an invoice showing VAT calculated on a discounted amount but the discount isn’t taken up by the customer, you don’t need to change the VAT amount.

Position from 1 April 2015. For supplies made after that date you can choose to issue an invoice showing the VAT on either the full or discounted amount. You must then check when your customer pays. If they qualify for the discount and you have charged the full VAT, you must issue a credit note. But if you have charged VAT on the discounted amount and they don’t qualify you will have to issue another invoice for the extra VAT only.

After 31 March 2015 if you offer customers a discount for early payment and charge VAT on the reduced amount, you will have to issue a second invoice for extra VAT if they don’t qualify. A better solution is to charge VAT on the full price and if they qualify for the discount send them a credit note