On June 11, 2020 the Court of Justice of the European Union (‘CJEU’) gave its judgement in case of Vodafone Portugal (C-43/19).  The case concerns whether VAT is due on amounts received by Vodafone from customers that have terminated their contracts early and before the end of the contractual tie-in period.

Facts of the Case

Vodafone Portugal (Vodafone) supplies telecommunication services including mobile networks, broadband services etc. In the content of its business it concluded various contracts with its customers for rendering e-commerce services. Some contracts included special promotions subject to the condition for the customers to agree upon a minimum contract period. In some cases, however, a customer will terminate the contract before the end of the tie-in period.Failure by the customers to comply with such tie-in period resulted in them having to pay a termination fee amounting to certain pre-determined costs, which cannot exceed the cost to the supplier of making the service available to the customer, computed in accordance with Portuguese legislation.

Vodafone had accounted for VAT on the income but then lodged an appeal to the Portuguese courts arguing that the amount it received from the customer was outside the scope of VAT as it was compensation for loss of income

Following a tax litigation, the Portuguese authorities raised questions to the CJEU as to whether the termination fees would be subject to or free from VAT.

Court Decision

The CJEU decided that the termination fees at hand are subject to VAT, for the reason that the termination fees (i) have been pre-agreed upon and (ii) equal a certain statutory cost base.

According to the Court, the method of determining the amount payable by the customer in cases where a contract is terminated early and before the expiry of the tie-in’ period is immaterial. What matters is that the payments are set in the terms and conditions of the contract between the supplier and the customer.

The Court considers that when a customer enters into a contract with Vodafone (or any other similar supplier of telecommunications services) it is, essentially, granted the right to benefit from those services and it does so in the full knowledge of how much it must pay by way of consideration. If a customer chooses not to avail themselves of the services or decides to terminate the contract early, this does not alter the fact that the right to the services was granted at the outset for the agreed consideration. The regular monthly payments are part of the contractual consideration payable by the customer to the supplier as are any early termination charges.

The Court also considered that there was no merit in Vodafone’s claim that the payments represented compensation or damages as such a classification would be counter to Portuguese law which expressly stipulates that suppliers cannot levy payments by way of damages or compensation. The Court hence ruled that such compensations received by Vodafone do fall within the scope of VAT.

Practical impact

The Court of Justice has ruled that, in an economic context, a supplier determines the price for its service and monthly instalments, having regard to the costs of that service and the minimum contractual commitment period. The amount payable in the event of early termination must be considered an integral part of the price which the customer committed to paying for the provider to fulfil its contractual obligations. We would therefore recommend to (timely) conduct a brief VAT check on non-compliance / early termination clauses in commercial agreements.

In practice, we often see payments referred to, for example, as contractual penalties, damages or severance pay, to which VAT is not applied. The judgment again confirms that it is not possible to simply treat all sanctioning instruments as outside the scope of VAT. It is necessary to assess each case individually. We recommend that businesses with similar contractual tie-in periods to analyse and, if the case, to correct the VAT treatment applied to the amounts invoiced to clients further to the early termination of contracts.

Our team is here to discuss the impact of this judgment on your Company with you, help in determining the correct VAT treatment and provide recommendations regarding the actions to be taken in case corrections are required.

For more information, contact our VAT Partner @Kyriakos Fili.