Change ahead for VAT treatment of prompt payment discounts

Do you offer discounts to your clients for prompt payment? If so, you need to be aware of the upcoming changes to prompt payment discounts. From 1 April 2015, these will affect the VAT treatment of prompt payment discounts which are most commonly applied to business to business transactions. The changes are aimed at aligning UK VAT legislation with EU VAT legislation. We recommend getting up to date with them ahead of time because they are fairly complex and could well affect your business.

Current VAT treatment

Currently, suppliers account for VAT on the discounted price being offered for prompt payment (even when the discount is not taken up).

For example, if you provided a £100 invoice with a 5% discount, the invoice would be:

Goods: £100
VAT (20% of £95):  £19
Invoice total:  £119

Both supplier and customer would post £19 to their VAT account and this would remain the VAT due/recoverable, regardless of whether or not the discount was taken up. Up till now, HMRC has NOT required businesses to alter the amount of VAT invoiced and accounted for if the discount is not taken up.

New VAT treatment from 1 April 2015

Here’s the difference – now there is an assumption that the discount is not taken up and the example becomes:

Goods: £100
VAT (20% of £100): £20
Invoice total: £120

Then if the discount is subsequently taken up and the customer pays £95+£19 VAT = £114, you as the supplier would issue a credit note. This would show:

Goods (5% of £100): £5
VAT (20% of £5): £1
Invoice total: £6

The total on the VAT then becomes £20 – £1 = £19.

Of course, if the discount isn’t taken up, no further entries are needed.

What could this mean for your business?

  • Because this is a fundamental shift for automated accounting packages, it will demand changes to the software. As a supplier in this situation, you may want to consider whether it is still actually worth your while offering the discount.
  • Even if your business doesn’t use automated accounting packages, you will still also need to change your invoicing procedures if you offer discounts.
  • If your business is partially exempt, these changes could have an impact on the amount of VAT you can recover under the partial exemption scheme.
  • Even non-VAT registered clients could be affected because they may face additional VAT costs when they don’t take up a discount.

We’re here to help make sense of all accounting issues for small and medium sized businesses. If you have any questions at all about the upcoming changes to prompt payment discounts, don’t hesitate to get in touch!

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