VAT on advance payments

What it means

VAT on advance payments is the rule under which a payer’s tax liability arises on the day it receives a payment before goods or services are supplied, not on the day of supply. It is an exception to the ordinary rule on the tax point.

It applies to every advance received or deposit where it is clear what supply is being paid for. If it is not known what will be supplied, as with a multi-purpose voucher, no liability arises. Nor does it apply to advances for an intra-Community supply of goods to another EU state.

The payer must issue an invoice for the payment within 15 days of receiving it. An advance invoice or pro forma invoice issued before payment does not count: these are merely requests for payment and do not become tax documents.

How it works in practice

In the books the payment received is recorded as a liability towards the customer, and output VAT is calculated from it on a tax-inclusive basis, treating the whole amount as a price including VAT. The invoice for the payment goes into the control statement like any other invoice issued.

The final invoice deducts the payment already taxed from the total, and only the difference is taxed. The final invoice must refer to the payment, and we set up clients’ invoicing so that advances are matched automatically and nothing is taxed twice.

If the deal is cancelled and the deposit refunded, the payer corrects the tax with a corrective invoice to the payment invoice. If the customer paid in a foreign currency, the conversion uses the exchange rate on the day the payment was received.

What to watch out for

The most common mistake is issuing the tax document only with the final invoice. If a month end falls between receiving the deposit and the supply, the tax is reported in the wrong period and the mismatch shows up in the control statement of the customer, who has already deducted the tax.

The opposite mistake is taxing a payment request the customer never paid. VAT arises only when the money is received, not when an advance invoice is issued, and by paying tax on an unpaid deposit the company needlessly finances the state out of its own pocket.