VAT – Prompt Payment Discounts

With effect from 1 April 2015 H M Revenue and Customs (HMRC) have changed the VAT rules concerning Prompt Payment Discounts (PPD). The previous rules required any businesses offering a PPD, e.g. a 5% discount if the invoice is paid within 14 days, to account for VAT based on the discounted price of the goods or services sold, even if the PPD is not subsequently taken up by the customer, i.e. they pay after the 14 day period has expired.

Under the new rules the businesses providing the goods or services (suppliers) and the customers of those goods and services will have the following obligations:

Suppliers

  • When the VAT invoice is raised the supplier must account for VAT on the full price of the goods or services and enter that invoice and VAT into their accounts records accordingly.
  • The supplier must show the terms of the PPD on the invoice.  They will not know if the discount has been taken up by the customer until they receive payment (or the time limit for the PPD has passed).  They must therefore decide before they issue the invoice which of the following processes they will implement to adjust their accounts if the PPD is taken up by the customer.  They must either:

a) Issue a credit note to reflect the reduced value of the supply (since they will have received less money than is shown on the invoice if the PPD is taken) or;

b) Include appropriate wording on the invoice when it is sent to the customer to include the terms of the PPD and a statement that the customer can only recover as input VAT the VAT that is actually paid to the supplier, such as:

“A discount of X% of the full price applies if payment is made within Y days of the invoice date.  No credit note will be issued.  Following payment you must ensure you have only recovered the VAT actually paid”.

HMRC also provide a suggested template for an invoice which can also state the net value of the supply, the VAT thereon and the total amount to be paid on the assumption that the PPD is taken up.

If the discounted price of the goods or services is then paid by the customer, the supplier must adjust their accounting records to reflect that the VAT payable on the supply has reduced from the original value included in the records.

Customers

The situation for customers can basically be summarised into three categories, as follows:

a) Upon receiving the invoice the customer pays the discounted price of the invoice.

b) The customer pays the full price of the invoice.

c) The customer does not pay the invoice when first issued so initially enters the VAT invoice on to their accounting records showing the full amount of the supply, i.e. without the PPD and VAT.

Under (a) above, the customer will simply need to include in their accounting records the reduced value of the goods or services (having taken the PPD off the invoice total) and the VAT thereon and no further action will be necessary.

Similarly, under (b) no further action will be necessary since the customer can simply record the full value of the invoice in their records and pay over to HMRC the VAT on the total value of the invoice without the discount.

Under (c) the customer will initially need to record the full price as shown on the invoice in their records and the VAT thereon.  If they subsequently comply with the terms of the PPD and pay the reduced sum they will need to adjust their accounting records as follows:

  • If the supplier issued an invoice with the appropriate wording included, as mentioned above, they will simply need to adjust within their records the reduced amount of VAT and reduced amount of supply accordingly.  They should then also retain appropriate evidence to show the date and amount of reduced payment, e.g. a copy of the bank statement in addition to the invoice of course.
  • If the supplier did not take this approach when issuing the original invoice and instead chooses to issue a credit note, the customer will have to wait for that credit note to arrive from the supplier before they can reduce the amount of VAT that is payable on the supply.

There is the possibility in the above scenarios that some VAT adjustments will be required in a different VAT period to that in which the original supply is recorded.  If that is the case then normal rules must be followed for making adjustments on a subsequent VAT Return.

The above is for general guidance only and no action should be taken without obtaining specific advice