Termination fees often subject to VAT
Following a ruling of the CJEU, termination fees in the event of early termination of a contract are often triggering VAT. Especially in B2C-situations, were the customer does not have a right to recover VAT, such VAT is likely to result in a significant VAT burden for businesses.
On June 11, 2020 the CJEU issued its long-awaited judgement in the Vodafone Portugal case (C-43/19). In the context of its business activities, Vodafone Portugal concluded various contracts with its customers for rendering e-commerce services. Some contracts included special promotions subject to the condition for the customers to agree upon a minimum contract period. Failure by the customers to comply with such tie-in period resulted in them having to pay a termination fee amounting to certain pre-determined costs, computed in accordance with Portuguese legislation.
The CJEU was asked to rule as to whether the termination fees would be subject to or free from VAT. In short, the CJEU decided that the termination fees at hand are subject to VAT, for the reason that the termination fees (i) have been pre-agreed upon and (ii) equal a certain statutory cost base. It remains uncertain whether terminations fees would be free from VAT, if the termination fees would not have been pre-determined or would have served as a compensation of damages.
In many industries, not only e-commerce, non-compliance with contractual obligations often results in the customer having to pay termination fees. From the Vodafone Portugal case, it can be derived that termination fees are often triggering VAT. However, we feel that – under certain conditions – termination fees could still be free from VAT. We would therefore recommend to (timely) conduct a brief VAT check on non-compliance / early termination clauses in commercial agreements.
Our advisers of the Loyens & Loeff Indirect Tax team are happy to be of assistance should have any question or require further information.