Essential VAT Changes to Prompt Payment Discounts

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As if tax issues were not complicated enough,  HMRC has added in some new rules in relation to VAT that have kicked in on the 1st of April of 2015. Whether you already have a VAT-registered business or if you intend to register for it in the near future, you should keep on reading this article.

The new rule is related to“settlement discounts”, also known as “prompt payment discounts”. These are usually offered in order to invite customers to pay their invoices more quickly. If they pay by a certain date, they will receive a discount on the original price. However, up until now, the VAT was always calculated on the discounted rate, regardless of whether the customer paid for it in time or not. So, even if the customer paid  the full amount on the invoice, the reduced VAT amount would have been applied.

The change has made the VAT charged to be on the amount that is actually paid. If the customer pays early, a discounted VAT will be applied, if the customer does not pay early, then VAT will apply to the full amount.

This new system will lead to some difficulties because when the invoice is given to the customer, it is not possible to know whether the customer will pay for it in time or not. Thus, restraining us  from knowing whether the VAT will be applicable on the discounted rate or on the full rate. But HMRC has come up with two solutions for this issue:

  1. Credit notes: first of all, an invoice is issued to the customer at the full price and, therefore, the full amount of VAT is charged. However, the terms and conditions of the discount available are also stated on the invoice. If the customer meets these terms, then they can be issued a credit note for the discount and the reduced VAT.
  2. Statement of acknowledgement: this one is a little bit more complicated; upon issuing the invoice to the customer, the client would include a statement that says that the customer is only allowed to claim back the VAT that has actually been paid. In this case, HMRC has actually made a suggestion for the wording that is to be used in the statement:

“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.”

Regardless of which method you choose, the customer and the supplier will both need to keep accounting records to show how the VAT was calculated and exactly how much will have to be paid. This means keeping copies of invoices and credit notes and keeping tabs on all bank statements.


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