VAT reduced on advance payment if customer cancels?

Tax point

Our subscriber has correctly accounted for VAT when they receive the full payment from the students before the start of the course. A tax point is created on the earlier date of when a sales invoice is issued or advance payment is received from a customer. The reason that a tax point is created is because the payment is non-refundable so it relates to an actual supply of goods or services.

If our subscriber uses the cash accounting scheme, the payment date will be relevant rather than any earlier sales invoice date.

What about the fees?

Our subscriber thinks they are entitled to a partial refund from HMRC on their return(s) if the students do not benefit from all of the classes for which they have paid. The logic is that VAT is only payable on supplies of goods or services that have taken place:

• if a student leaves after stage one, our subscriber’s view is that two thirds of the output tax should be reduced on the return that includes the withdrawal date
• if the student leaves after the second stage, one third of the output tax should be reduced on the return that includes the withdrawal date.

The reason this approach is wrong is because the advance payments from the students create a tax point for the right to attend all three parts of the course, and that outcome does not change if they drop out part way through their studies.

The right to receive a benefit or service is always classed as a supply.

Example. Jim is a member of his local gym and signed an annual contract on 1 January to use the facilities, paying £40 per month plus VAT. He did not use the gym in April because he was working out of the country. The gym must still account for output tax of £8 on his April payment because he still had the right to use the gym; it was his decision not to use the facility.

If the gym gave Jim a refund of £48, or did not charge him for April, this will avert an output tax liability for this month. In effect, his annual membership fee has been reduced from £480 plus VAT to £440 plus VAT by this reduction.

Issue a credit note?

Our subscriber has asked if it would change the position if they issued a credit note to the students for part of the fees, based on the formula above, even though they have no intention of making a refund. Can they reduce their output tax liability based on this document?

The answer is “no”; the law was amended on 1 September 2019 to deal with this type of situation.

Real world value. Output tax can only be reduced by a supplier if the customer is given “real world value” with the credit, i.e. it is either refunded to the customer’s bank account or is immediately offset against other unpaid sales invoices relevant to the same customer.

The phrase real world value is used in HMRC’s manual, which confirms that “decreases in consideration will only qualify for a VAT adjustment when there has been an actual refund in money by the supplier.”