Based on the fact that the supplier, i.e. the seller who receives the payment, is obliged to pay VAT for the payment of the invoice received, this seller must issue a tax invoice to the other party that reflects the VAT included in the invoice amount. The party making the payment and who is the recipient of the services should then be entitled to claim a deduction of input VAT from the VAT incurred, in so far as the payment was made in the course of his taxable business activity. It follows that the party receiving the payment is left out, while the party making the payment benefits from the claimed deduction. In view of the above, sellers who conclude out-of-court settlements, in particular the seller who receives payment of a settlement amount, are reminded that it is important to explicitly state in the settlement contract what the payment of the settlement is for and whether the payment of the agreed settlement is exclusive or includes VAT if VAT is due. If the VAT settlement agreement is silent, the payment is deemed to include VAT if it is made for the services supplied. As a result, the seller who receives such a payment is required to record the exit tax on the settlement amount in the amount of the tax part, which leaves the recipient out of his pocket and ultimately settles for less. Previous HM Revenue & Customs (HMRC) guidelines, which have now been withdrawn, stated that where customers were required to withdraw from contracts to receive goods or services, these charges generally did not apply to a supply and did not fall within the scope of VAT. Compensation for breach of contract was considered as compensation for loss of profits and not as consideration for a supply (and is therefore not subject to VAT). According to the previous position, a settlement could cause problems with respect to multiple claims, where some compensation was avoidable and others were not. It was good practice to clearly allocate and clarify the elements of the comparative amount subject to VAT and non-VAT, failing which HMRC risked considering the entire payment as a single composite supply (most likely SUBJECT TO VAT). The VAT treatment of payments made under a transactional agreement depends on the amount paid. Compensation paid for loss or damage suffered is generally not subject to VAT because it is not paid for the supply of anything, whereas a settlement payment made to a seller in exchange for consent waives its right to take legal action in connection with an existing claim constitutes consideration for a service and is subject to VAT.

This blog builds on our recent blogs on HMRC`s controversial changes to VAT and early termination payments, as well as VAT on intellectual property compensation schemes. As noted earlier, the retroactive nature of the changes and the resulting risk of having to cancel historical settlement payments raised a number of issues. This has now led hrMC to plan to issue further guidance on this issue. However, it was the retrospective nature of the changes that was really problematic because it gave HMRC the power to review historic institutions over a retrospective period of four years. It is important that both parties (but in particular for the beneficiary) include the words “plus VAT if applicable” in the settlement agreement. Indeed, settlement agreements, under which compensation payments are made for loss or damage suffered, may also provide that the payment must be paid in full and definitively. However, such a clause is included in the agreement to facilitate settlement. The settlement payment is made to compensate the plaintiff for any loss or damage suffered, and no part of the payment is made in exchange for the plaintiff`s waiver of his or her right to sue. In this scenario, the beneficiary of the compensation payment does not pay VAT.

Press release 82/87 was issued with the aim of limiting its application to genuine disputes. If a settlement agreement was formulated in such a way that the plaintiff waived the right to sue the defendant for a sum of money, it was not a delivery. If the agreement not to proceed and settle amicably confirms a previously agreed price or a reduction to a previously agreed price, VAT will be adjusted using the credit note mechanism with reference to the agreed final price. The situation in which the payment was made subject to a court order remained unchanged. Remember that a silent contract is a contract that includes VAT, and it is too late for the beneficiary to return for that extra 20% once the agreement is signed. It follows that if a disputing party agrees to waive its right to bring legal action against another party against a settlement payment, the settlement payment constitutes an identifiable payment based on reciprocity and directly related to the supplier party`s right to take legal action against the other party. Where the assignment of such a right by a seller takes place in the context of or for the promotion of his business, payment of the invoice received constitutes consideration for the taxable provision of services. As a result, the seller who receives payment of the invoice is required to record the outgoing tax applicable to him in the amount of the tax part (15/115) of the payment. This processing applies in cases where an initial contract allows for such termination, as well as where a separate agreement has been concluded. This change therefore affects breach of contract payments, lump sum damages, cancellation fees, early upgrade fees and similar payments, whether or not these payments are called offsets or damages.

What happens if counterclaims are incorporated into the settlement? Unfortunately, VAT cannot be cancelled by offsetting payments against each other. If a settlement agreement expressly provides for the settlement of a claim X and a counterclaim Y, where Y is VATable, but X is not, you cannot deduct Y from X and say that the sum is not subject to VAT. Given the significant change in the UK`s VAT policy in this regard, if you have received a payment under a settlement agreement that was previously considered to be outside the scope of VAT, you will need to check as soon as possible whether VAT is now being collected. Where is the place of delivery? If it is not the United Kingdom, the British VAT is not relevant. Here, the usual rules apply, for example, if a German auto parts manufacturer pays a British car brand a settlement amount for defective parts in cars sold in the United States, the place of delivery (if any) is Germany and there is German (not British or American) VAT law at stake As with any payment that can attract VAT, it is important to get the right treatment. If the payment is subject to VAT, the plaintiff will require the defendant to pay VAT in addition to the principal payment of damages or compensation. If the payment is made under a settlement agreement, the agreement must provide that VAT is payable in addition to the principal amount, otherwise the payment will be treated as VAT included. If the defendant is a company with a full VAT refund, he should be able to recover the VAT, but only if the VAT was actually due.

In practice, and to the detriment of the seller receiving a settlement payment, it appears that the parties to an out-of-court settlement often ignore the VAT treatment of settlement payments and, as such, do not take into account the VAT element when agreeing on a settlement amount or concluding the contract in relation to that agreement. If the settlement agreement does not specify whether payment of the settlement is made with or without VAT, the payment of the invoice is deemed to include VAT in the amount of the standard rate of 15% within the meaning of Article 64 of the VAT Act. As a result, the supplier seller, i.e. the recipient of the payment, is obliged to deposit the VAT there and cannot claim the amount of VAT from the other party in addition to the payment of the invoice already agreed under the settlement agreement. This is in line with the approach of our courts, which have concluded that the obligation to pay VAT for a transaction for which VAT is due rests with the supplier seller and not with the recipient. For example, the non-inclusion of VAT in an out-of-court transaction is as follows: this applies in particular to scenarios where additional compliance with VAT rules is required. For example, if the amount is a refund and triggers a credit and manages the excess head and exit tax, everyone must agree before the payer contacts HMRC for an exit tax refund. However, if a termination payment was not made in accordance with the terms of the original contract, the separate termination agreement concluded at the time of termination stated that the payment had been made in exchange for a “right of termination” subject to VAT. If a settlement payment relates partly to a service and partly to the compensation of a seller for the losses incurred, an appropriate distribution of the payment within the meaning of § 10 para. 22 UStG is required.

The part of the payment relating to the losses incurred is not subject to VAT, while the part of the payment received in return for the services supplied is subject to VAT. It is therefore advisable that the settlement agreement clearly specifies the settlement payment to be made for each part of the claim. Parties to a dispute often opt for an “out-of-court” settlement as opposed to a protracted legal dispute where the outcome is uncertain and legal fees are high. .