TT219: Settlement discounts
Until the start of this month, most businesses offering a Prompt Payment Discount (PPD) as part of their standard terms only accounted for VAT on the discounted price, even if the full price was subsequently paid.
Unfortunately, due to doubt over whether PPD rules complied with EU law, changes were made to the UK legislation in the Finance Act 2014. These changes came into force for the majority of businesses on the 1st April 2015. Businesses must now account for VAT on the amount they actually receive, rather than the discounted price.
This will leave many businesses in the uncomfortable position of not knowing how much VAT to charge when they initially raise a sales invoice, or how to go about accounting for this unknown.
HMRC suggest two possible solutions to this conundrum. As ever, they both place the burden and cost of compliance firmly on the shoulders of the business:
- Issue an invoice for the full amount of VAT on the original, undiscounted net sales value (albeit showing the rate of the PPD offered on the invoice) and if the PPD is taken up, issue a credit note for the difference. or;
- Issue an invoice, again for the full amount of VAT on the original, undiscounted net sales value, ensuring it contains the terms of the PPD (which must contain, but not necessarily be limited to, the time by which the discounted price must be made) and a statement that the customer can only recover as input tax the VAT paid to the supplier. If the customer complies with the terms of the PPD and takes the discount on payment then no credit note need be issued, but the VAT should be accounted for on the lower amount received. You need to be able to show the receipt of the smaller amount if HMRC challenge the reduced VAT declared.
Of these two options, we would imagine that most businesses would choose the second. However, a large part of the decision may be taken out of the business’ hands and simply come down to how well the software it currently employs copes with the change.
There are two risks with using option 2. Firstly, the vendor might not make the correct disclosure on the invoice to allow option 2 to be operated or, secondly, the customer might take the discount even when they have not complied with the terms of the PPD (typical, huh?). This would leave the vendor:
- needing to issue credit notes (if it decides to allow a discount outside the PPD terms);
- with a liability to account for more VAT than it has actually been paid (HMRC will expect this); or
- chasing customers for the additional sums due (because PPD conditions have not been met).
Chasing customers for additional sums will be particularly irksome when dealing with large numbers of relatively small value transactions. There will also be a potential for disputes in dealing with marginally late payments. The customer may feel that he paid in time or, perhaps being unaware of the cumulative impact, may consider that the supplier is being unreasonable – particularly if past practice has been to take a relaxed view on marginally late payments.
This also gives the potential risk that if you issue an invoice before a VAT quarter end and the customer takes the PPD after the quarter end you cannot reduce the VAT declared until the following quarter.
Of course all the complexity described above relates to the supplier. It will be duplicated for customers, who will also be required to ensure that they claim the right amount of VAT and make the correct adjustments depending on whether they meet the PPD terms and the policy that any particular supplier has adopted.
If you would like any further information on these changes, or would like Barnes Roffe LLP to review how your accounting systems will cope and whether your invoices are compliant, please do not hesitate to get in touch. It is also worth considering whether in your particular circumstances it might be possible to agree a tailored approach with HMRC that reduces some of the problems these new rules present.Talk to Barnes Roffe today