It’s a standard practice for VAT registered Freelancers and Accommodation providers to request a deposit, part or full payment ahead of supplying the service or goods. It acts a security blanket in case of a no-show or cancellation. 

Until now, if you had a customer who paid a deposit, but later on cancelled the service and was not eligible for refund, the deposit was exempt from VAT.

So let’s say Mr Smith paid in a deposit for his hotel room – £100 + £20 VAT, he cancelled 1 day before arrival and the policy says that due to late notice, he was not eligible for a refund. The Hotelier did not have to pay VAT on that deposit as the current rules state:

“Our current policy lets businesses treat many payments for services and part payments for goods, as outside the scope of VAT where the customer does not:

• use the service
• collect the goods”

Source HMRC Revenue and Customs Brief 13 (2018)

Following judgements of the Court of Justice of the European Union (CJEU) in the Air France-KLM and Firin OOD cases, HMRC will be changing the way VAT applies to cancellations as of 1st March 2019. The new rules mean that you will be required to pay VAT on each part payment received that was not subject to refund.

To show it as an example:

You received a room booking from Mr. Smith for 21st March. Your hotel took a deposit of £100 + £20 VAT and it’s in your policy that you do not give refunds on cancellations. Mr. Smith cancels his booking on 28th February. He does not receive a refund as per your policy and you do not have to pay VAT on the deposit received.

However, if Mr Smith cancels his booking on 5th March, the deposit he paid is subject to VAT as you do not offer refunds, new rules apply and it’s assumed the deposit already allowed for VAT.

In essence, you have to pay VAT on any deposit you keep. Freelancers who offer partial refunds of deposits, depending on how much work they’ve managed to complete before cancellation of service, pay VAT on the amount they keep to cover for that work.

If this has already been your policy and you’ve only just found out that these part payments were outside of VAT scope in case of cancellation, unfortunately you cannot make any adjustments to previous VAT periods to treat supplies in line with former policy, as no error has been made.

If you usually split the payments into a small deposit and a larger payment upon completion and add the full amount of VAT to the second payment, you may want to re-think your pricing structure.