When can you adjust returns for customer refunds?

Cash accounting scheme

If your business uses the cash accounting scheme (CAS), you will adjust the VAT on any credit note you issue based on the date that you repay the credit to your customer. The date of the credit note - which will usually be issued first - is irrelevant. This is because your VAT declarations if you use the CAS are wholly based on payments made and received.

Example. Bill did some building work for Ben and charged £10,000 plus VAT, i.e. £12,000. He issued his invoice on 31 March 2023. Ben queried the quality of some of the work, so Bill issued a credit note for £4,000 plus VAT on 31 May 2023. Ben paid £6,000 plus VAT on 10 July 2023 to settle his debt.

If Bill completes calendar quarter VAT returns and uses the CAS, he will account for £1,200 VAT on his September 2023 return, i.e. the return which includes the payment date of 10 July 2023. There will be no declaration on either the March or June returns because no payments have been made or received.

You can use the CAS if you expect your taxable sales in the next twelve months will be less than £1.35 million ex. VAT.

Credit note must be repaid

For non-CAS users, HMRC announced a change of policy from 1 September 2019, meaning that you can only adjust your output tax when you reduce the amount owed on a sales invoice if you actually repay the credit to your customer. It is not enough to just issue the credit note and repay the customer over a period of weeks or months.

The revised policy is relevant to all situations when the original price of your goods or services is reduced after the supply has taken place.

The regulations require you to issue a credit note to your customer within 14 days of giving the customer a refund. However, it makes sense to raise the credit note at the same time as you issue the refund to your customer.

Offset situations

As well as the situation when you make a payment to your customer for a credit, a payment is also classed as being made if you offset a credit note against other liabilities on their ledger. So, e.g. if your customer owes you £20,000 on their sales ledger account and you issue a credit note for £2,000, payment is deemed to have been made on the date when you issued the credit note because your customer now owes you £18,000, i.e. a reduced amount.

Details included on credit notes

The credit notes that you issue must contain a unique identifying number and clearly show the date that you issued it. It must also show the number and date of the original sales invoice which the credit note is adjusting. The narrative on your credit note must be sufficient to identify the goods or services that you supplied, as well as the amount and rate of VAT.

If your customer is VAT registered and fully taxable, i.e. has no restriction of input tax, then you can process the price reduction without adjusting the original VAT that you charged. Your customer must agree to this option.