I think VAT should be charged on a late payment fee.
That is not something for the program to impose. In many—possibly most—jurisdictions, late payment fees are considered a form of interest and are specifically not considered a taxable supply or service. In some other jurisdictions, they are considered an administrative cost incurred in the enforcement of contract terms and are likewise not considered to result in the taxable supply of goods or services. In other words, the common interpretation is that VAT on late payment fees would be taxing something that was never purchased or delivered.
If it’s considered taxable supply in at least one judistriction, then this use-case needs to be supported.
The reason I wrote “…many—possibly most—jurisdictions” is that I searched but could not find a single one where late payment fees are subject to VAT. That does not, however, guarantee there are none. However, basic principles of VAT laws are fairly uniform around the world, with most borrowing from the same sources.
No user has ever complained about this before. If someone knows of a jurisdiction where late payment fees are taxable, they should respond with a relevant link.
I am not an expert in this. maybe @Hennie knows the answer
In New Zealand, at least, a late payment fee is regarded to be a taxable supply (it is the opposite of an early payment discount and, in that sense, is a ‘consideration’ for supply), but a penalty interest payment is GST exempt [ Sections 5(25) and (26) of the Goods and Services Tax Act 1985, amendments added in 2012]. However, any penalty interest element of a late payment fee is GST exempt (and good luck to anyone who can really separate the two, but that’s what the Act says).
The New Zealand law is almost identical to versions I found in my research of either (a) legislation or (b) explanatory guidance published by tax authorities in several countries. The key in such jurisdictions lies in how the late payment charge is determined. (In some cases, the law or guidance goes beyond the somewhat confusing language @Gillrich cited to give an actual example.) If a fixed fee is imposed, say $50, for missing a payment due date, that is not considered interest and is taxable. But when a percentage of the amount outstanding is charged per defined time period—such as X% per month, the way Manager calculates late payment charges—it is interest and is not taxable.
Users in a country applying these definitions would not use Manager’s built-in late payment fee feature in the first situation. Instead, they would issue a new or revised invoice with a separate line item for the fixed charge. That line item would be subjected to VAT with a regular tax code. In the second situation, a much more common one, they would use the built-in late payment fee option, which would not be subject to VAT. Therefore, no change is needed in the program for those countries.
My original question remains, but would benefit from further detail. Does anyone know of a tax jurisdiction where percentage fees for a specified time period on overdue invoice balances are subject to taxation? To qualify, the law would need to be stated or interpreted differently from the New Zealand example.
This is what Dutch VAT legislation says about Late Payment Fees:
When you charge a Late Payment Fee on your invoice you don’t calculate VAT on this amount, because you are not sure whether your customer will pay you late.
In case he does pay late and he pays the late payment fee, you have to calculate and pay the VAT on this amount
Invoice amount € 10000,-
VAT 21% € 2100,-
Fee 1% € 121,-
Invoice total € 12221,-
When he pays € 12221-, you have to pay VAT 21% of € 121,- which is 21/121 x 121 is € 21,-
The customer may not deduct € 21,- as claimable VAT unless an addtional invoice is send by you for the Late Payment Fee.
I hope this info will help you guys.
This is an interesting situation, @Hennie. And it seems different from what @Frankie suggested and seems to assume would be the solution (applying VAT directly to the late payment fee). In effect, you are saying you must collect and remit VAT on the full amount received. But you cannot add VAT to the late payment fee, because it would then appear on the tax invoice and the customer would be entitled to recover it as VAT paid. Yet, if you do not charge the customer for the late payment fee on the sales invoice, but receive payment for it, the sales invoice will be overpaid.
This seems to require that, if you are going to going to charge late payment fees, you must always do so with a separate sales (tax) invoice, not with Manager’s built-in feature. From this reasoning, I draw two conclusions:
- Manager still requires no modification.
- Procedures for late payment fees to be followed by any given business must be determined with a careful understanding of the law in the applicable jurisdiction. In the Dutch case, the procedure would seem to demand separate sales invoices for late payment fees.
Do you agree? Or do you see this handled in different ways in your accounting practice?
Take my example. In case the customer pays the total of € 12221,- he has two options:
- He accepts the fact that € 21,- is not reclaimable as VAT
- He asks for an additional invoice where VAT is included.
The last option than means that I have to issue a creditnote for € 121,- and issue a new invoice where I charge € 100,- late payment fee and add the additional € 21,- VAT.
This creates a lot of administrative work. In practice, hardly nobody pays a late payment fee in case it is charged simply because of the fact that they know that no company will take the risk of losing a customer in case they persists in paying the late payment fee. In early days, when bankinterests were high it was quite a phenomenon, but nowadays hardly no company charges late payment fees anymore. As a matter of fact, none of my clients charges late payment fees to their customers.
The example invoice @Frankie posted, is fully in line with Dutch legislation and is exactly according to what I described above.
This is what I suspected from your description of the Dutch law. It would lead to administrative headaches that are not worth the effort. Nevertheless, I still do not think applying VAT to late payment fees within the program makes sense. It does not solve any problems, but creates more.
Manager requires no modification. Full Stop. In case you would charge VAT on late payment fees on the initial invoice and the customer doesn’t pay it, you have to correct your sales invoice and probably tax-returns. That would make it even more complicated and creates more headaches as you already wrote.