With Effect From 1st of April
Amendments to VAT rules for prompt payment discount with effect from 1 April 2015
This article summarises the changes to the way that businesses must calculate the VAT on invoices which offer a discount for prompt payment. The current UK legislation is the Value Added Tax Act 1994 (VATA 1994), Schedule 6, paragraph 4. UK legislation is to be amended with effect from 1 April 2015 to bring the UK into line with the relevant European legislation which is the Principal VAT Directive (Directive2006/112) Article 79.
Reference material for this article
The content of this article has been taken from various government publications:
- VAT: Prompt Payment Discounts, Consultative Document issued 17 June 2014
- VAT: Prompt Payment Discounts, Summary of Responses issued 10 December 2014
- Revenue and Customs Brief 49 (2014) issued 22 December 2014
and is the latest information available at the time of writing.
Current position (valid until 31 March 2015)
Prompt Payment Discount (PPD), or Cash Discount as it is sometimes unofficially termed, is a discount offered by the supplier for when payment is made within an allowed timeframe. HM Revenue & Customs (HMRC) has until now interpreted UK legislation to allow suppliers to account for VAT on the discounted price offered for prompt payment even when that discount is not taken up.
Net invoice price £500
Terms 2% 7 days
Cash discounted price for calculating VAT is £500 - £10 = £490
VAT to be added to the invoice is 20% of £490 = £98.00
The invoice will therefore show
Net Invoice Price £500
Gross Invoice Price £598
Terms 2% 7 days
If the discount is taken, the customer pays £490 + £98 = £588
If the discount is not taken, the customer pays £500 + £98 = £598
Historically PPDs have mainly been offered between VAT Registered Traders, business to business (B2B) and recipients have generally been entitled to recover any VAT charged. PPDs are increasingly being offered to final consumers (B2C) who cannot recover the VAT charged. In particular, HMRC have identified several instances of suppliers of B2C services offering PPDs in the telecommunication and broadcasting sectors. Under the existing interpretation this results in a tax loss to HMRC where PPDs are not taken up.
The rules are to be changed to bring them into line with the European Principal VAT Directive (PVD) which requires VAT to be accounted for on the consideration actually received. The existing UK legislation may be interpreted as being in line with the PVD but has a degree of ambiguity so it will be amended to provide clarity on the VAT treatment of PPDs.
This measure was announced for the first time in the Budget 2014 and after consultation will come into effect for all invoices issued after 1 April 2015.
From 1 April 2015 the change will mean that, in relation to supplies made on or after this date, businesses that allow or receive PPDs will have to make some adjustments to how they account for VAT in circumstances where a VAT invoice is required and the terms on which the goods or services are supplied allow a discount for prompt payment.
If the discounted price is paid in accordance with the terms before the invoice is issued the invoice should show the discounted price paid.
If the discounted price is not paid before the invoice is issued then the invoice must show the undiscounted amount plus VAT, and the rate of the discount offered.
So in the above example the invoice would be laid out:
Net Invoice Price £500
Gross Invoice Price £600
Terms 2% 7 days
If the customer takes the discount he or she will pay £600 less 2% which is £588 (the same as previously).
However if they do not take the discount and pay the full amount HMRC will gain £2 on the transaction for the increased VAT.
The question has been raised as to how the discount and the reduced VAT will be posted into the accounts and also shown in the VAT return.
On issuing a VAT invoice, suppliers will enter the invoice into their accounts and record the VAT on the full price. However certain information is required on the invoice as follows:
- The terms of the PPD (PPD terms must include, but need not be limited to, the time by which the discounted price must be made).
- A statement that the customer can only recover as input tax the VAT paid to the supplier.
Additionally, it might be helpful for invoices to show:
- The discounted price
- The VAT on the discounted price
- The total amount due if the PPD is taken up.
As the supplier will not know if the discount
has been taken-up until they are paid in accordance with the terms of the PPD offer, or the time limit for the PPD expires, the supplier will need to decide, before they issue an invoice, which of the processes below they will adopt to adjust their accounts in order to record a reduction in consideration if a discount is taken-up.
Option 1 - one method is to issue a credit note for the discount taken and the related VAT after payment has been made. This can then be posted through the accounts with the net amount posted to the discount account rather than debiting the sales or sales returns account (or the relevant purchases or purchases returns account if the discount refers to paying a supplier).
However HMRC have agreed that issuing a credit note for the discount plus VAT is time consuming and expensive (including the cost of re-training staff and amended software packages) so an alternative option is available.
Option 2 - the second method is to show the terms on the original invoice along with the relevant information that will be sufficient to allow both supplier and customer to notify the discount and the effect on VAT to HMRC without the need to issue a credit note.
HMRC recommends businesses use the following wording on the invoice:
“A discount of X% of the full price applies if payment is made within Y days of the invoice date. No credit note will be issued. Following payment you must ensure you have only recovered the VAT actually paid.”
If a business has adopted the second option, the VAT invoice, containing appropriate wording as described above, together with proof of receipt of the discounted price in accordance with the terms of the PPD offer (e.g. a bank statement) will be required to evidence the reduction in consideration, and the reduction to the supplier’s output tax (in accordance with Regulation 38 of the VAT Regulations 1995).
If the discounted price is paid in accordance with the PPD terms, then the supplier must adjust their records to record the output tax on the amount actually received.
If the full amount is received no adjustment will be necessary.
On receiving an invoice offering a PPD a VAT registered customer may recover the VAT charged, in accordance with VAT Regulation 29 of the VAT Regulations 1995.
As adjustments may take place in a VAT accounting period subsequent to the period in which the supply took place the method of adjustment needs to comply with Regulation 38 of the VAT Regulations 1995 (SI 1995/2518).
In practice this will mean:
- If the customer pays the full price they record it in their records and no VAT adjustment is necessary.
- If the customer pays the discounted price in accordance with the PPD terms on receipt of the invoice they may record the discounted price and VAT on this in their accounts and no subsequent VAT adjustment is necessary.
- If the customer does not pay when the invoice is first issued, they must record the full price and VAT in their records as shown on the invoice. If they subsequently decide to take-up the PPD then if they have received an invoice setting out the PPD terms which states no credit note will be issued they must adjust the VAT in their records when payment is made. They should retain a document that shows the date and amount of payment (e.g. a bank statement) in addition to the invoice to evidence the reduction in consideration.
If the supplier’s invoice does not state that a credit note will not be issued, the customer must adjust the VAT they claim as input tax when the credit note is received. They must retain the credit note as proof of the reduction in consideration.
To view a sample invoice the following link will take you to the relevant page on the GOV.UK website where the sample may be downloaded.
Effect on the VAT Return
Any reduction in VAT will need to be shown in either box 1 (for sales) or box 4 (for purchases). There is no effect on either box 6 or box 7 as the amount of discount itself does not appear in the VAT return.
When using a computerised accounts package, you should check with your software supplier how to post any adjustments required to ensure that supplier and customer balances and also the relevant VAT balances are correctly amended.
Where a supplier receives a payment that falls short of the full price but which is not made in accordance with the PPD terms it cannot be treated as a PPD. The supplier must account for VAT on the full amount as stated on the invoice. If the amount not paid remains uncollected it will become a bad debt in the normal way. If a price adjustment is agreed later, then adjustment must be made in the normal way e.g. a credit note.