The UK issued a consultation paper on 31 May 2013 in respect of the value added tax (VAT) treatment of refunds paid directly by manufacturers to consumers. The current UK VAT law permits a business that is in a direct relationship with a customer to adjust the VAT on a supply if the amount paid for that supply is subsequently changed, for example by a refund. However the law does not clarify the VAT position where a manufacturer that does not have a direct relationship with a customer makes a payment subsequent to the original supply.

This situation arises for example where a customer finds that goods are faulty or damaged, or is dissatisfied with them and takes them back to the retailer who sold them. If the retailer takes back the goods and gives a refund to the customer it is normally the retailer who makes a VAT adjustment for the amount refunded. The retailer would also make a VAT adjustment if there is any other subsequent adjustment to the original price at which the goods were sold by the retailer. Sometimes however the purchaser makes a claim for the whole or part of the price of the goods from the manufacturer, for example where there is a serious fault with the item sold. This situation is not specifically addressed in the VAT regulations.

The Elida Gibbs case in the European Court of Justice (ECJ) established that a manufacturer could make an adjustment to its VAT where refunds were paid directly to final consumers under a sales promotion scheme. However HMRC did not interpret that case as applying to refunds in respect of goods returned by customers when they are damaged or faulty. This type of payment by a manufacturer has been treated as compensation or an ex gratia payment to the customer and has therefore been regarded by HMRC as outside the scope of VAT. Following a review of the law, however, HMRC has come to the conclusion that the manufacturer is entitled to adjust the VAT originally accounted for on the sale if goods are returned and a refund paid directly by the manufacturer to the customer.

The consultation aims to establish how frequently this type of payment by a manufacturer arises; the range of circumstances in which this occurs; the necessary adjustments to the VAT law to cover this type of payment; and how much of an administrative burden any change in the rules would place on the parties. A change is then to be made to the VAT regulations 1995 to ensure that the VAT accounted for by the manufacturer is proportional to the amount paid for the supply of goods after adjustment for the amount refunded.

The changes to the VAT rules would only be applicable when the refund paid by the manufacturer related to the original supply of the goods. The rules will not apply where the refund related to a loss occurring after the original supply or where a refund is made in excess of the original consideration for the supply.

The issue of a voucher by the manufacturer would be treated differently because this relates to a discount on a future supply of goods. Any VAT adjustment would only arise where a voucher is used by a customer in a future purchase and a payment is then made by the manufacturer to the retailer in respect of that voucher. In the case of a multi-purpose voucher, the payment by the manufacturer to the retailer would result in a reduction in the manufacturer’s output tax and the VAT rules need to be changed to clarify this. In the case of a single purpose voucher, the manufacturer would recover input tax on its supply to the retailer so this is not covered by the changes.

The consultation requests comment on the scope of refunds to be covered by the changes, including for example a provision that the refund should relate to the original supply of goods and that it should be a monetary refund in relation to the goods or a payment in relation to redeemed multi-purpose vouchers. Manufacturers are invited to supply information on the extent to which they give such refunds and to offer advice on any other situations that HMRC should consider as included in the definition of refunds. HMRC gives examples of situations that would not be considered to be refunds for this purpose and asks for comments on these. The consultation also covers the situation where goods are sold under finance agreements.