Prompt payment discounts and VAT
ICAS explores changes to rules for calculating the VAT due on sales made on goods and services where the supplier offers a prompt payment.
The rules for calculating the VAT due on sales made on goods and services where the supplier offers a prompt payment are changing with effect from April 2015.
This is a change that is being made to the UK rules to bring them into line with the Principal VAT Directive and it will have a significant impact on businesses that offer discounts to their customers and the VAT accounting arrangements for both the supplier and purchaser.
Members in business, tax advisers in practice and auditors need to understand and plan for the impact of the changes.
The current UK rules mean where a supplier offers a discount, then the VAT is calculated assuming the discount is taken up by the customer. For example if the total value of the goods is £100,000 and the supplier offers a prompt payment discount of 10% then the VAT invoice would look like this:
VAT at 20% - based on £90,000
Prompt payment discount offered of 10% where payment made within 21 days of the date of the invoice.
Both parties would post the £18,000 to their VAT account and there would be no adjustment if the discount was not actually taken up – the total payable by the customer would remain at £118,000 as the VAT amount would not be adjusted up to £20,000 even if the discount was not taken.
The new rules change the position and add more steps to the VAT accounting processes. Under the new rules, the assumption is that the discount is not taken up – so in the example above the invoice would be for £120,000 assuming VAT in full at 20%.
If the customer does actually take up the discount then the supplier issues a credit note in the amount of the discount for both elements of the supply, including the £2,000 credit for VAT. Both parties will then process the paperwork in their respective accounting systems so that the debits and credits balance out – always a happy moment for accountants.
The position in the above example under the new rules if the purchaser did take up the discount would be:
- Invoicing stage – at this stage the discount is ignored so that the invoice is for £120,000 and both the supplier and the purchaser account for the £120,000 in their accounting system with £20,000 posted to the VAT account
- Payment – when the purchaser makes the payment and takes advantage of the discount this will be the trigger for a credit note. In this example the purchaser would pay £108,000 representing £90,000 for goods/services and £18,000 of VAT
- Credit notes – once the payment has been received the supplier will be required to issue a credit note for both the VAT and goods and services element. Both the supplier and purchaser will have to reflect these in their accounting records.
The requirement to issue credit notes to reflect discounts is a fundamental change to the way in which accounting software packages in the UK have been configured. This change will require updates to software and processes to make sure that the business is charging the right amount of output VAT where it offers prompt payment discounts. It will have a significant impact on businesses that offer prompt payment discounts and may even lead such businesses to consider if the administrative burden associated with the additional credit notes now required is worthwhile.
The changes will also have an effect on accounting software providers and they will have to update their packages to reflect this change in good time for implementation on 1 April 2015.
The Government has been consulting about the impact of the changes on business and ICAS has issued a response to the consultation which has outlined our concerns about the practical impact of these changes. HMRC has indicated the UK rules have to change to align with the principal VAT directive so businesses can expect these changes to be implemented. The challenge for business will be to make sure it can comply with the additional requirements of the new rules.
This change may have other consequences particularly for partially exempt businesses who may find that these changes have an impact on the prices they are charged by suppliers and the amounts of VAT they can recover under their partial exemption schemes. It is a change that will have wide repercussions.