The client also charges a 20% deposit as an advance payment in order to secure the future hire of goods. Occasionally customers cancel their order or do not show up by the time specified that they will be held until, and in these situations, the client keeps the deposit. Is there any output tax to declare on this?
A security deposit does not represent consideration for a supply and therefore does not create a tax point. This is because the payment is to be returned in full to the customer for the safe return of the goods hired.
If the goods are not returned in their original state or in accordance with the terms in the contract and your client decides to retain the security deposit, whether in full or in part, the money retained is outside the scope of VAT as a compensation payment. The customer has breached the terms of the contract by damaging the goods.
A deposit paid to secure a piece of equipment would create a tax-point, as this is advance consideration for that supply as per section 6(4) of VATA1994. A tax point arises when a VAT invoice is issued or a payment is received prior to the service being completed.
If the order is then cancelled, this may be a breach of contract so the monies originally taken can be treated as compensation, or it may be that the customer has the right to cancel, and because no supply takes place, the cancellation charge is outside the scope of VAT. Output tax accounted for on receipt of the deposit can then be reversed.
For further information regarding deposits please refer to the following in HMRC’s internal manuals, VATTOS5120 and VATSC53600.
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