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In the case of Phoenix Optical Technologies Limited (“Phoenixâ€) vs HMRC the two parties disputed whether the transfer of an asset as part of a financial settlement was a supply for VAT purposes.The case arose from a customer of Phoenix, with whom it had a contract, becoming dissatisfied with the Appellants performance. A settlement was reached which required Phoenix to make payments to the customer and in addition, transfer a piece of diamond turning machinery valued at approximately £57,000, inclusive of VAT. The transfer of the machine was made as Phoenix did not have the funds to pay the claim fully. Both the machine and the payments were to be considered part of a financial settlement. Compensation payments are normally not deemed consideration for a supply and therefore, are outside the scope of VAT.  However, HMRC's original ruling stated that Phoenix were liable to account for output tax on the transfer of the machinery as the transfer amounted to a supply of goods. There was no dispute that the cash payments were outside the scope of VAT but the transfer of the machine was classed as a consideration for the agreement of the customer not to pursue its claim for damages. This would mean the transfer of the machine was a VATable supply and Phoenix were liable to account for approximately £9,500 of output tax. The first-tier tribunal dismissed the appeal and sided with HMRC highlighting that although generally compensation payments are not consideration for a supply, the circumstances in which the compensation arises must be fully considered.  As there had been a supply of goods in this instance, that supply must attract VAT at the standard rate. If you or your client are involved in any compensation agreements, seek VAT advice on our free helpline to clarify your VAT responsibilities and avoid falling foul of a HMRC ruling.

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