Running a business is hard enough without chasing unpaid invoices or handling customers who walk away from contracts early. Beyond the immediate hit to cash flow, there’s a less visible risk that catches many companies off guard: value-added tax, or VAT.
VAT is meant to be neutral. Businesses collect it from customers and pass it on to governments. But when customers don’t pay or walk away from a deal, the reality can look very different. Companies can end up remitting VAT on revenue they never actually receive, turning what should be a consumer tax into a direct cost for the business.
VAT on Unpaid Invoices and Bad Debt Relief
In most countries, businesses account for VAT when they issue an invoice or deliver a service, not when they actually receive the cash. That means if a customer disappears without paying, the company may have already sent the VAT to the tax office. Suddenly, a tax designed to fall on consumers becomes a cost for the business itself.
There is a safety net known as “bad debt relief,” which lets companies reclaim VAT on invoices that have gone bad. The idea is simple, but the rules differ from country to country. In the United Kingdom, for instance, there’s a straightforward six-month rule: if a debt is unpaid for six months and you’ve written it off in your books, you can claim back the VAT. The Netherlands has a similar approach but uses a longer, one-year timeframe before you can recover the funds on your return. Germany, however, is much stricter. It’s not enough to show that a payment is overdue. To reclaim the VAT, you must have objective evidence proving the debt is truly uncollectible and the money is gone for good.
These differences highlight a deeper issue: while the EU has a single VAT system in theory, in practice businesses face a patchwork of national rules. For companies trading across borders, this inconsistency creates real headaches. Until the EU agrees on a harmonized approach, businesses need to understand the local rules wherever they operate and factor that risk into their finance policies.
VAT on Contract Cancellations and Early Termination Fees
Cancellations are an unavoidable feature of modern business, whether it’s a gym membership, a mobile phone contract, or a flight ticket. Yet when a customer walks away, the VAT consequences are rarely obvious. The fundamental question is deceptively simple: should VAT be charged on cancellation fees or any other amounts received by a business from a customer who will not use the service?
There is no blanket answer. VAT legislation does not explicitly address these situations, leaving the issue to the courts. Over the years, the EU Court of Justice (CJEU) has played a decisive role in shaping the rules, and its judgments reveal a clear shift. Where cancellation fees were once treated largely as compensation outside the scope of VAT, the Court has increasingly classified them as consideration for services and therefore taxable.
In 2007, the Société thermale d’Eugénie-Les-Bains case (C-277/05), the Court ruled that deposits retained by a hotel after a cancelled booking were not subject to VAT. The reasoning was straightforward: the deposit was compensation for the hotel’s loss, not payment for a service. This set an early precedent for treating cancellation fees as non-taxable damages.
That position began to change in 2015, in the joined Air France-KLM and Hop! Brit-Air cases (C-250/14 and C-289/14). Here, the Court held that non-refundable unused flight tickets remained subject to VAT. The passenger, by purchasing the ticket, acquired the right to be transported, and the airline met its obligation by making the service available. The fact that the customer did not show up did not alter the taxable nature of the payment.
The logic was carried further in the 2018 MEO case (C-295/17). A Portuguese telecom company charged customers early termination fees equal to the outstanding contract value. The Court ruled these fees taxable, stressing that they were not damages but, in economic terms, payment for the right to have services available throughout the contract period.
Two years later, in Vodafone Portugal (C-43/19), the Court refined this approach. The company charged lower termination fees, calculated based on the benefits customers had already received, such as discounted equipment or waived installation charges. Despite this difference, the Court reached the same conclusion: the payment was still part of the overall contractual price and therefore subject to VAT.
Another illustration of this principle came in the Apcoa Parking case (C-90/20). The Court ruled that “control fees” charged when drivers broke parking rules, such as failing to display a ticket or occupying a reserved space, were still subject to VAT. Even though Danish law described these charges as penalties, the Court looked beyond the label. What mattered was the economic reality: the driver had made use of the parking space under agreed conditions, and the fee formed part of the overall price for that service. The judges stressed that under EU law it is the existence of a direct link between the payment and the service provided that determines taxability, not the terminology used in national legislation.
What emerges from these rulings is a pattern. Where a payment is tied directly to the supply of a service, whether the customer uses it or not, it will usually be considered taxable. If the fee is a genuine form of compensation, such as a forfeited deposit reflecting the supplier’s loss, it may fall outside VAT.
Managing VAT Risks for Non-Payments and Cancellations
For CFOs and finance leaders, the message is clear: VAT on unpaid invoices and cancellations isn’t a theoretical issue but a real cash flow threat that can quietly erode margins. When customers fail to pay, companies are forced to navigate a maze of national relief rules and evolving court judgments, and too often they end up absorbing the cost themselves. Anticipating this risk and planning ahead can spell the difference between a manageable expense and an unexpected hit to the bottom line.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organizations with which the author is affiliated.