In this article, Kevin Hall gives his expert insight and answers a readers question in Taxation Magazine.
Query 19,830 – Laurie
My client runs a haulage business, which is registered for VAT. The business has recently agreed a compensation deal with a German manufacturer, linked to faulty parts in some of the vehicles, which had to be replaced at a big cost to my client.
Instead of paying a monetary amount, the German supplier has instead agreed to supply three new lorry engines, which will be imported from Germany with a value of £1 shown on the paperwork. The client has accepted this proposal. However, what do we do about VAT – both import VAT on arrival and also output tax on the client’s next VAT return? Is customs duty an issue as well when the goods arrive at Dover?
My client will be declared as the importer of record when the goods arrive.
Is this a barter transaction or compensation?
Compensation is outside the scope of VAT, but recent court and tribunal decisions have persuaded HMRC that arrangements labelled ‘compensation’ are usually supplies for VAT purposes and this is now a tricky area.
The first step is to determine whether this is a barter transaction. This will affect the transactions which are to be considered for VAT purposes and the values for each transaction. For example, on the one hand, the client might have repaired the faults, with the German manufacturer covering the expenditure. On the other hand, the German manufacturer might be supplying three new engines, which the client in effect pays for with the expenditure on fault repairs. A review of the contractual terms would be a good starting point, both for the lorries and for the compensatory new engines. On output tax, if there is a barter transaction, the client could be making a taxable supply to the German manufacturer (for example of a legal right), valued at the expenditure on fault repairs. However, it is likely that this is genuine compensation and not a taxable supply. The taxable status would depend on the precise facts and the contractual review will be helpful.
Regarding imports, goods (the three new engines) will enter the UK and import VAT will be payable. Import duty should also be considered.
The client will wish to understand whether there are additional costs to them. Import duty will be a cost, but for import VAT the client should consider whether they are entitled to recover this in their VAT returns. Alongside the usual question of whether the imported engines are attributable to taxable supplies, it is important to determine whether the client owns the engines (which seems likely) because otherwise they cannot recover the import VAT.
Import value should be considered. The German manufacturer will import the goods showing a value of £1 on the paperwork, but the client will be the importer responsible for declaring an accurate value.
If the client is paying £1for the three new engines, they should consider adding the significant value of the fault repairs to calculate the full value of the compensation payment and the full value of the new engines. This would lead to higher import VAT (potentially recoverable) and import duty for the client.
Finally, there is some good news. For repaired defects if the seller reimburses the buyer under warranty for the cost of the warranty work carried out by them or on their behalf, they can submit a claim for repayment of import duty to Customs National Duty Repayments Centre. This is a difficult scenario and will require some work to get right.
Originally written for Taxation Magazine