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VAT and prompt payment discounts

Posted: January 13, 2015

Many businesses making supplies to customers will be tempted to persuade those customers to pay as quickly as possible for those supplies, after all, lengthy delays can be costly in financial terms and also in terms of maintaining good commercial relationships.

One way of incentivising customers to pay quickly is to offer them a discount based on how long it takes them to pay. For example a 10% reduction if payment is received within 14 days can make a significant difference to the customer, and help to ensure that cash-flow is kept relatively healthy.

However, the treatment of VAT on such discounts is set to change from 1 April 2015.

The current position is to assume that the discount has been taken, in other words the VAT is calculated and declared on the discounted total.

For example, if a supply is made for a total of £150,000 the VAT amount (at 20%) would ordinarily be £30,000.

Assuming a prompt payment discount of 10%, the VAT invoice could look like this;

Goods

£150,000

Discount for prompt payment = 10%

£135,000

VAT @ 20%   (£135,000 x 20%)

£27,000

TOTAL INVOICE PRICE

£162,000

Prompt payment discount offered of 10% where payment made within 21 days of the date of the invoice.  

Both the supplier and the purchaser would use the £27,000 VAT figure for accounting purposes, with no adjustment needed if the payment terms were to be exceeded.

From April 15, the amount to be calculated and accounted for will be based on the amount actually received, and is on the assumption that the discount is not applied. This will mean that suppliers will need to adjust their accounting accordingly in the following ways:

Example 1 – If payment is made before invoicing – the amount paid will dictate the VAT amount.

A 10% discount for prompt payment is offered, and payment is made immediately. The VAT on the discounted amount is shown on the invoice and accounted for accordingly.

Example 2 – If payment is made after invoicing – the VAT treatment will depend on the time of receipt of payment.

If payment is received outside of the prescribed time period for discounting, then no adjustment is required as the VAT is calculated on the full, undiscounted value and remains the same.

If payment is received within the prescribed time period the original proposal was that a credit note must be issued to adjust the VAT amounts to reflect the discount.

Recent consultations and representations from various interested groups have lead to HMRC amending this, and indications are that the guidance – once it is published – will allow businesses to add suitable wording to the original invoice. This would effectively request that the customer adjusts their own VAT to reflect any discount that might arise, thereby avoiding the need to issue and account for credit notes.

The changes being implemented from April 2015 will mean that accounting and invoicing software and systems will need to be adjusted to adopt the amendments.
For more information on this, or any other VAT query, please contact Greg Mayne on 01227 454627, or email VAT@burgesshodgson.co.uk