From 1 April 2015 VAT registered traders AND their customers need to be aware of an important change to the way that ‘prompt payment discounts’ are accounted for to ensure that UK procedures are aligned with EU legislation. This change has already taken effect from 1 May 2014 for supplies of broadcasting and telecommunications services.
The Current System
Under the current system for general traders, VAT is charged on the goods value of the invoice net of any prompt payment settlement discount which may or may not be taken up by the customer when the invoice is eventually paid.
For example, assume a VAT registered business sells standard rated goods on credit to another business for £1,000 with a 10% prompt payment discount offered if the invoice is paid within 7 days.
VAT at 20% is charged on £900 (i.e. £1,000 less 10%) so only £180 of VAT is accountable by the trader to HMRC. The total amount payable by the customer would be shown as £1,180 on the invoice with no adjustment to the VAT amount irrespective of whether the discount offered was taken up.
Apparently the above rule has been seriously abused whereby artificial settlement terms were being offered to final consumers thereby significantly reducing the amount of VAT accountable by the supplier with a significant loss of tax revenue to the Government.
The New Rules
From 1 April 2015 registered traders must account for VAT on the ‘goods’ value of the invoice ignoring any prompt payment discounts which may be offered.
Therefore in the above example the VAT charged would be £200 with the total value of the invoice being £1,200. If the customer takes up the 10% discount terms then the trader will normally need to issue a credit note for £120 reflecting the 10% discount given on both the goods value and VAT element of the original invoice.
The issue of credit notes relating to prompt payment discounts will be a fundamental change to the way that accounting software is currently designed so that software suppliers will need to ensure that procedures are updated correctly for users from 1 April 2015.
Following a consultation period, HMRC have made available an alternative system to issuing credit notes whereby the invoice MUST contain the following information:
- The terms of the prompt payment discount
- A statement that the customer can only recover as input tax the actual VAT paid to the supplier.
HMRC also recommends the following information also be shown in a note on the face of the invoice:
- The discounted price
- The VAT on the discounted price
- The total amount due if the prompt payment discount is taken up
Where a supplier adopts this optional method then evidence of the transaction will need to be retained via a copy of the appropriately worded invoice and a bank statement recording the discounted amount received.
Position of Customers
Where any prompt payment discount is NOT taken up then the customer should record the full invoice value in the normal way.
Where the customer pays the discounted price on receipt of the invoice they must record the discounted price and related input tax in their accounts. In such cases no further adjustment is required.
Where however the customer does not settle the invoice when first issued they must initially record the full value of the invoice and related VAT in their accounts. If they subsequently take up the discount terms then:
- If a credit note is issued ~ the customer must adjust the VAT claimed as input tax on receipt of the credit note, which should be retained as evidence.
- If the supplier advises that NO credit note is to be issued ~ the customer must adjust the VAT claimed when the invoice is settled and retain the invoice and relevant bank statement as evidence.
Payments outside the prompt payment terms
Where a customer either deliberately or inadvertently takes the discount outside of the prompt payment terms, the short-fall must be treated by the supplier business as an outstanding debt. If the amount remains uncollected then it should be treated as a bad debt in the normal manner.
HMRC have issued Revenue and Customs Brief 49 (2014) on this topic together with an exemplar of a prompt payments discount invoice which can be accessed by clicking on the following link:
If you require assistance in implementing this change or would like advice on Value Added Tax generally then please do not hesitate to email us at: firstname.lastname@example.org or call us on 01633 215544