Can Irish telcos legally charge VAT on contract cancellation charges?

The remarkable prevalence of 18-24 month contracts in the mobile market means bill-pay consumers are increasingly likely to find themselves breaking their contracts and incurring cancellation fees. Personal experience, and a little bit of research, suggests that people in this situation may be unlawfully charged for Value-Added Tax (VAT).

So, what’s the story?

In 2008, following a ruling by the European Court of Justice (ECJ) and subsequent changes to Irish law, Revenue told providers of goods and services that VAT would not be levied on forfeit deposits or cancellation charges.

Here’s the direction from Revenue on the effect of those changes as it relates to cancellation charges (eBrief No. 49/2008):

3.2. A charge levied by a supplier when a customer makes a cancellation (“cancellation charge”) and a supply does not take place, is to be treated as falling outside the scope of VAT by virtue of it being regarded as compensation and not a payment in respect of a taxable supply.

And:

5.4. Where a supplier levies a charge on a customer in the event of the customer cancelling an order or request for a supply of goods or services and the supply does not take place, VAT is not due on the “cancellation charge” as set out in paragraph 3.2 above.

That Revenue Notice came into effect on September 28, 2008. If Revenue was no longer levying VAT on cancellation charges, what business did providers have in collecting it on them? As the Law Society’s Taxation Committee noted, they were to be treated as falling “outside the scope of VAT”.

In my experience, operators from Three Ireland demanded €715.20 to cancel a 10-day-old contract including VAT at 23%. I was told the cancellation fee being demanded was 18 times my monthly subscription of €40. Having come across this blog post, I queried the €164.50 VAT charge.

It was hard to understand how Three Ireland could be collecting VAT on Revenue’s behalf if the State stopped levying it on cancellation charges five years ago. And how could VAT be charged absent the “direct connection with the supply of [a] service” specified in the ECJ ruling?

My experience does not seem to be an isolated one.

In a 2012 thread on Boards.ie, an Eircom representative does not deny that VAT is charged on cancellation fees but suggests the company is doing so on Revenue’s instructions, and that the money is going to them. He also tells consumers not to expect a quick answer on the legal ramifications of the European Court of Justice ruling.

Two very lively threads on O2's website suggest that the Telefónica-owned provider is also suffering from some confusion on the application of VAT. O2 representatives found it hard to answer simple questions about it, blandly asserting that the rules were being correctly applied after 10 weeks of badgering. They did not engage with questions about the ECJ ruling or the Revenue notice.

The main upshot of the EJC case was that it allowed providers to reduce their VAT liability in the respect of forfeit deposits. Indeed, providers were entitled to four years’ of VAT discounts in respect of VAT charged on deposits foreited by their customers in that period.

Because, deposits are treated as prepayments made in advance of supply, they remain subject to VAT. If the deal fall through, the VAT is no longer due. Indeed, a receipt must be issued to the customers in these cases reflecting the reduced invoice. The Revenue Notice of 2008 does not specify how to treat VAT charged on cancellation charges because they are not subject to that tax in the first place.

Given the level of apparent confusion here, one wonders if providers could also be reducing their VAT liability in respect of cancellation charges?

One thing is certain, however, the big loser here is the consumer. The 2008 Revenue Notice is clear. Cancellation charges are not subject to VAT. Despite this, it appears that the misapplication of VAT to cancellation charges may be widespread and systematic.

Given that VAT has not been due on cancellation charges for nearly six years, we need to ask a few questions here:

  1. What is the legal position with regard to VAT on cancellation charges?
  2. What are the current practices of all major Irish telecoms?
  3. How do they compare to the law?
  4. How much money has been collected in this way from consumers?
  5. Did it go to Revenue?
  6. Can customers who pay VAT on cancellation charges claim it back?
  7. Are Revenue and ComReg aware of this issue?
  8. Have they taken any steps to bring clarity to the matter?
  9. Are other providers adding VAT to cancellation charges?
  10. Are any providers reducing their VAT liability in respect of cancellation charges?
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