VAT information sheet 03/14: treatment of refunds made by manufacturers

Published 2 April 2014

1. Purpose of this Information Sheet

This Information Sheet explains the VAT treatment of certain “refunds” made by manufacturers (and other “first suppliers”) direct to “final consumers” who have purchased their goods from a final supplier (usually a retailer). An explanation of what these terms mean in this context is given in section 1.3 below.

1.1 Readership

Any manufacturer or other first supplier in the UK who makes refunds direct to final consumers (see paragraph 1.3.2).

Any VAT registered final consumer who receives a cash refund from a first supplier in relation to goods purchased from a retailer (see paragraph 1.3.3).

1.2 Background

Under EU law the net amount of VAT collected by HM Revenue and Customs (HMRC) on a supply to a final consumer cannot be greater (nor less) than that due on the total amount paid by the final consumer. If the final consumer receives a refund or reimbursement of the purchase price, then the total amount paid by him or her will be reduced and the VAT previously accounted for must be adjusted accordingly.

Normally, it is the retailer who will refund money to the customer if goods are faulty or damaged. Where the goods are subject to VAT, the retailer must make an adjustment under Regulation 38 of the VAT Regulations 1995 (SI 1995/2518) (“Regulation 38”) to reclaim the VAT paid to HMRC on the original transaction. Also under regulation 38, a VAT registered final consumer must make a corresponding adjustment in relation to any VAT reclaimed on the purchase of the goods.

However, in some cases, (e.g. where the goods have a major fault) the final consumer seeks a refund of some, or all, of the price paid by him or her for the goods from the manufacturer rather than from the retailer.

The European Court of Justice in the case of Elida Gibbs (C-317/94) held that a manufacturer was entitled to adjust its VAT to take account of reimbursements paid directly to final consumers under a promotion scheme. In that case, the consumer would send a coupon to the manufacturer and claim a cash refund of part of the price paid by him or her to the retailer.

The Elida Gibbs case did not concern manufacturers providing refunds to dissatisfied consumers, and HMRC previously saw these as compensation payments which are outside the scope of VAT. Having looked again at this issue HMRC now accept that refund payments of this type can in some cases represent reductions in the consideration received by the manufacturer.

The government has therefore introduced a new Regulation 38ZA which expressly provides for adjustments in both Elida Gibbs reimbursement and dissatisfied customer refund scenarios.

Manufacturers may therefore be entitled to seek recovery of VAT not already adjusted in past periods subject to the normal capping rules (see paragraph 3 below).

Revenue and Customs Brief 78/09 set out HMRC’s view of the application of the Elida Gibbs judgment and business promotion reimbursements schemes. This Information Sheet replaces Brief 78/09 and sets out HMRC’s view of the application of Regulation 38ZA to both business promotion reimbursements and manufacturer refunds for damaged or faulty goods.

1.3 How does the law work?

1.3.1 When does the law take effect?

The new Regulation takes effect from 1 April 2014 and covers any refund (as defined in that regulation) made in a VAT period that ends on or after that date.

For example:

  • if you have 3-monthly VAT periods and the period ends on 31 May 2014, the legislation covers refunds made on or after 1 March 2014
  • if you are annual accounting with the period ending 31 July 2014, the legislation covers refunds made on or after 1 August 2013

Where a refund is made in the same VAT period as the manufacturer’s original supply the manufacturer may, subject to the conditions set out in this Brief, amend the VAT to be declared in that period’s return.

For refunds made prior to 1 April 2014 please see Section 3 below.

1.3.2 Who is a manufacturer?

Although we generally refer to a manufacturer in this Information Sheet, the legislation applies to any “first supplier” of goods in the UK ie any UK VAT registered business that starts the supply chain in the UK. Thus it also covers, for example, a VAT registered importer of goods from an overseas manufacturer.

1.3.3 Who is a final consumer?

The “final consumer” is the person at the end of the UK supply chain who purchases the goods to use. Generally these purchases will be for private use by non VAT registered consumers, but a VAT registered business which purchases goods for use in its business is also a “final consumer”.

1.3.4 What is a “refund”?

The term refund includes a cash payment in respect of damaged or faulty goods and a cash reimbursement paid under a promotion scheme (such as “cash back” deals or money off vouchers). In either case, the payment must represent a reduction in the consideration for the final supply of the goods. In all cases the refund must be made in cash, by cheque or by crediting the customer’s debit or credit card.

A manufacturer may provide a dissatisfied customer with a voucher, credit note or similar non-monetary credit or token that offers a future discount against further purchases or otherwise restricts the recipient as to its use. In such cases the manufacturer cannot adjust its VAT until the voucher is redeemed for goods and it pays the retailer.

The legislation only applies to the extent that the sum paid by way of cash refund or reimbursement is related to the original purchase price paid by the consumer. Payments that relate to compensation for a consequential loss or any amount of a payment made that exceeds the price that the final consumer paid for the goods are not included.

In effect, in the case of a cash refund, the consumer must be put in the position of:

  • never having purchased the product (ie. they return the goods and receive a full refund of the purchase price paid)
  • having paid a lower price for the product (ie. they retain the product and receive a partial refund of the purchase price paid)

1.3.5 Examples of payments covered by this change

The following are examples of where manufacturers are able to adjust their VAT:

  • payments in relation to “money back” promotions
  • payments for faulty products
  • payments for damaged products
  • payments made where the customer is generally dissatisfied with a product rather than being able to demonstrate a fault or damage and
  • payments made in connection with product recalls for safety, health or quality issues

1.3.6 Examples of payments not covered by this change

The following are examples of where manufacturers are not entitled to adjust their VAT:

  • payments to third parties to repair the goods with or without a free supply of parts to effect a repair - the test is whether the customer has received a refund against the consideration they paid for the goods and, if that is unaltered, then there is no adjustment to be made
  • payments to customers covering the cost of repairs the customer paid to third party repairers - this is “out-of-pocket” compensation to the consumer for additional expenditure and the original cost of the goods remains unaltered
  • payments for consequential loss (eg. damaged carpet following a washing machine leak, delayed delivery causing a customer to take a day off work)
  • cases where the goods are repaired, exchanged or replaced without any refund of part of the purchase price
  • payments in connection with the customer doing something material for the manufacturer, for example completing a survey or feed-back form (this does not include the simple action of returning a money-off coupon)

1.3.7 Can repayments be apportioned?

In some cases a payment may cover a number of different things as listed in 1.3.5 and 1.3.6. For example; a payment to a dissatisfied customer may include an element of compensation for consequential loss. In such a case, the payment can be apportioned as necessary.

1.3.8 Cross-border “refunds”

Where refunds are paid between businesses in different EU Member States, no VAT adjustment will normally need to be made where:

  • a UK manufacturer pays a refund to a business in another Member State, the cross border supply is unlikely to have attracted UK VAT
  • a UK business receives a refund from a manufacturer in another Member State, the cross border supply is likely to have been accounted for as a reverse charge intra-EU acquisition where the acquisition tax and the input tax would both need to be adjusted

1.4 Third party payments

Payments made to consumers by third parties (for example credit companies under Consumer Credit legislation or insurance payouts) do not represent refunds against the original purchase price. These payments are compensation even if the credit company or insurer subsequently recovers some or all of the loss from the retailer or manufacturer and so are not refunds, for the purpose of this change.

However, a manufacturer will be able to adjust its VAT in respect of payments that are made by an agent operating a refund service on its behalf (see paragraph 2.1).

2. Adjusting the VAT account

2.1 Manufacturer

HMRC do not prescribe the records that a manufacturer should maintain for the purposes of the new regulation, but they should be sufficient to enable HMRC to verify that the VAT credit has been correctly claimed. As the refund is outside the direct supply chain credit notes should not be issued.

Examples of records are:

  • correspondence between the final consumer and the manufacturer prior to a refund being agreed
  • documentary evidence provided by the final consumer to evidence the validity and the amount of their claim such as a copy of the invoice showing the price paid
  • money off coupons and details of payments to retailers or final consumers in respect of business promotions Where an agent handles refunds on behalf of a manufacturer, the manufacturer must only adjust its VAT account for payments when they have actually been made to consumers and not for any transfer of funds to the agent in advance or anticipation of them being made. When an adjustment is required, a manufacturer should adjust its VAT account by crediting the output tax side.

2.2 Consumer

The new provisions only apply to final consumers who are VAT registered and have claimed some or all of the VAT incurred on the purchase of the goods as input tax.

Any business in this position that receives a refund payment, must adjust its input tax claim accordingly.

Where an adjustment is required, a VAT registered final consumer must adjust its VAT account by debiting the Input tax side.

2.3 Retailers

The new provisions relate to payments made by a “first supplier” to a “final consumer” and any retailer (or other intermediary) will have no part in the change in consideration and should not make any adjustment to their VAT.

2.4 Change in VAT rates

The purpose of the legislation is to ensure that the correct amount of VAT is accounted for on the total amount paid for the goods in question by the final consumer. Therefore, the adjustment must be at the VAT rate that applied at the time of the final supply to the consumer and not the VAT rate (if different) that applied at earlier stages in the supply chain.

For example:

  • a manufacturer supplied goods at a VAT rate of 17.5% to a retailer. The VAT rate changes to 20% before the retailer supplies the goods on to the final consumer. The manufacturer must adjust the VAT accounted for by it at the 20% VAT rate
  • an importer supplied goods to a retailer at the 20% VAT rate. The VAT rate applicable to the supply by the retailer is the reduced rate of 5%. The manufacturer must adjust the VAT accounted for by it at the 5% VAT rate
  • a charity buys certain goods zero-rated from a wholesaler which were standard-rated for VAT when supplied by the manufacturer. The manufacturer cannot reduce its output tax in relation to any payment to the charity as it relates to goods that were supplied VAT-free to the charity

3. Refunds made in earlier periods

Where manufacturers have made refunds that are covered by the new legislation and have not previously adjusted their VAT they may now do so.

HMRC’s view is that any adjustments should properly be capped at 4 years from the end of the VAT accounting period in which the refund was made. There are a number of cases pending, including before the Court of Appeal, that deal with historical claims and time limits and HMRC will issue further guidance in the event that the outcome of any of these cases causes it to change its view.

If any business wishes to make an historical claim for a VAT repayment it should follow the guidance set out in Notice 700/45: How to correct VAT errors and make adjustments or claims.