Is VAT due on fees you charge to late-paying customers?

Consideration

The amount of VAT you pay on the goods and services you sell to your customers depends on the payment you receive, referred to as “consideration” in the legislation. In some cases, VAT can still be due, even if there is no payment received from your customer.

Example. Widgets Ltd has decided to give a crate of champagne worth £500 to each of its ten biggest customers. This is a supply of goods that exceeds the annual VAT-free limit of £50 per recipient for business gifts, so the company must declare output tax on the VAT return that includes the date of the gift. If the value of £500 excludes VAT, then output tax payable will be £100 per crate.

As the champagne was purchased for a business reason, input tax can be claimed by Widgets Ltd, assuming they hold a proper VAT invoice from the supplier etc.

Late payment charges

There is no supply of goods or services taking place when you make an extra charge to your customers because they have paid late. The charge is classed as a penalty that is outside the scope of VAT. However, it is important that you make it clear to your customers that the late payment charge is completely separate to your original supply:

• don’t issue an invoice for the charge - it is best to advise your customers with a letter or other form of written communication
• in the letter, make it clear how you have calculated the penalty so that HMRC can confirm that you are not charging an extra amount for the goods or services you have supplied.

Some extra charges issued to your customers will be subject to VAT, e.g. if you charge them an extra amount if they pay by a certain method - such as a corporate credit card - this will be treated as extra consideration for the goods or services.

Interest charge

Interest charged to your customers has a different VAT outcome to a late payment charge because it is classed as an exempt source of income for your business. In effect, it reflects the fact that money has been in the bank account of your customers for too long rather than your own, i.e. you have supplied them with a credit facility per VAT Notice 701/49. There is no output tax liability on exempt income but that is not the end of the story.

If your business uses the flat rate scheme, you will exclude interest received and late payment charges from the total business income to which you apply the flat rate percentage to calculate your VAT liability.

What about input tax?

If your business receives exempt income, you are classed as partially exempt and must therefore adjust your input tax claim; it cannot be claimed on expenses that directly relate to your exempt supplies. You must also apportion the VAT you reclaim on your business overheads. The interest that you charge to your customers will not create a partial exemption challenge because the input tax not claimed will be less than the partial exemption de minimis limits. This means that you can fully claim input tax on your expenses in the usual way.