Following EU Tribunal Cases (VAT being a European Tax and largely unaffected by Brexit); HMRC have changed their stance on many forms of compensation payment – and with particular regard to the Construction Industry – how Liquidated Damages are treated.
Previously compensation payments were seen as being Outside the Scope of VAT, as there was no ‘supply’ made in return, whereas the MEO & Vodafone Portugal cases have made them now consider these as true supplies. The phrasing used by HMRC is well written (although perhaps badly received) [Payments for] compensation do not arise in a vacuum – effectively they are directly linked to a contract for goods or services and thus follow the VAT liability of that contract. There is a similar stance with breach of contract payments, with the subsequent payment seen as additional fees to the lessor or Provider.
Of more concern is the statement from HMRC that any ‘missing’ VAT from payments such as these will be due from the trader, unless a specific ruling has been issued. This indicates retrospective corrections are due as I cannot envisage a situation historically where any ruling would have been needed – the previous HMRC guidance being pretty clear! If you receive liquidated damages, you’re not receiving payment for a supply by you and no VAT is due on that amount [ref VN 708 para 22.3].