Payment for early termination of the contract by the customer from the VAT point of view

Dispute in the original proceedings

The Austrian companies rhtb: projekt gmbh (hereafter ‘the Supplier’) and Parkring 14-16 Immobilienverwaltung GmbH (hereafter ‘the Customer’) have concluded a contract for the construction project. After the commencement of work, the Client stopped the project for reasons not attributable to the Supplier. The Supplier therefore, in accordance with the Austrian law, requested a payment of the agreed price less the costs saved as a result of the unjustified termination of the work contract in question.

As this amount was not paid, the Supplier brought an action for payment of the amount including VAT before the court of first instance, claiming that the Customer had withdrawn from the contract in question without justification and was therefore obliged to pay the contract price. The court of first instance granted the action stating that the price for the works which could not be carried out because of the termination of the contract was subject to VAT. However, the court of appeal later held that the amount due for the works not carried out was not subject to VAT because there had been no mutual performance between the parties.

Both companies appealed the decision to the supreme court. The latter decided to stay the proceedings and to refer to the CJEU the preliminary question whether the amount payable by the Customer to the Supplier is subject to VAT even if the work has not been fully completed, given that the Supplier was willing to complete the contract but was prevented from doing so by circumstances on the Customer's side.

Legal interpretation by the CJEU

The CJEU, referring to its earlier case law in Case C-43/19 Vodafone Portugal, held that a supply of a service subject to VAT only occurs where there is a legal relationship between the supplier and the recipient under which reciprocal performance is provided and the consideration received by the supplier represents the actual consideration for the identifiable service provided to the recipient. This is the case where there is a direct link between the service provided and the remuneration received. The consideration for the price paid at the time of the signing the service contract was the right to benefit from the fulfilment of the obligations arising from that contract, irrespective of whether the customer exercised that right.

A predetermined amount received by the supplier in the event of the early termination by a customer, or for a reason attributable to that customer, of a service contract which was intended to run for a certain period, where that amount corresponds to the amount which that supplier would have received during that period if there had been no such termination, must be regarded as remuneration for the supply of a service for consideration and, as such, be subject to VAT.

According to the CJEU, the same reasoning must also apply where the Supplier has already started to provide the services in question and was prepared to do so for the entire duration of the contract at a predetermined contractual price. In the present situation, the Supplier not only allowed the Customer to use those services but had already started to carry out the agreed work, had provided part of those services, and was prepared to do so until the end of the contract. The amount payable under the local Austrian legislation not only reflects the contractually agreed remuneration for the services rendered after deduction of the amounts saved, so that there is a direct link between the amount at issue in the original proceedings and the service rendered, but also provides the service provider with a minimum contractual remuneration.

In the Decision the CJEU also addressed the applicability of its previous conclusions in the Case C-277/05 Société thermale d'Eugénie-les-Bains (hereafter ‘Société thermale’), where it dealt with the issue of the application of VAT on non-refundable advances intended to compensate the provider for damage caused by the cancellation of a reservation by a customer. In this case, the CJEU came to the opposite conclusion, namely that the contractually agreed amount constituted a lump sum compensation for the damage suffered by the service provider because of the cancellation of the contract by the recipient, which was not subject to VAT. However, in the CJEU's view, the situation in the Decision is not comparable. In the Société thermale case, there is no direct link between the service provided and the consideration, since the reservation of a room does not constitute an independent and identifiable service. The non-refundable advance payment constitutes a lump-sum payment intended to compensate the service provider for the cancellation of the contract by the customer and does not therefore constitute remuneration for the services in question subject to VAT. 

Conclusion of the CJEU

In the light of the above considerations, the CJEU concludes that the amount to be paid after the Customer has terminated a validly concluded contract for the supply of that service, which is subject to VAT and which the Supplier has begun to supply and has been willing to complete, must be regarded as remuneration for the supply of the service within the meaning of the VAT Directive. That remuneration should therefore be subject to VAT.

How we can help you

In practice, in many cases it can be very difficult to distinguish whether a particular case concerns compensation for damages or another payment not subject to VAT, or whether it is a payment for a service provided which is subject to VAT.

If you are unsure about the nature of a penalty payment, we strongly recommend that you consult the matter with VAT experts, whenever you are paying or receiving the penalty. We would recommend that you pay close attention to this issue when entering contracts. 

If you are interested, we will be happy to help you review these problem areas and answer any questions you may have regarding this issue.

Authors:

Milena Drábová, Tax Department Manager

Lucie Smolová, Senior Consultant, Tax Department