VAT rates change rarely, but when they do, sometimes for a temporary period on specific goods or services, businesses spend months issuing credit notes for sales made at the old rate. The rule is simple: a credit note or refund reverses the original supply at its original rate.
Why the original rate applies
A credit note adjusts the consideration for a supply that has already been taxed. It is not a new supply. If the original invoice charged VAT at 20% and the rate is now 5%, the credit note reduces output VAT by the VAT actually charged, at 20%. Using the new rate would leave VAT overpaid or underpaid compared with what was declared.
Example
A hospitality business sold a £1,200 (including VAT) event package when the rate on that service was temporarily 5%. After the rate returns to 20%, the customer cancels part of the booking and receives a £420 refund.
| Original rate (correct) | Current rate (wrong) | |
|---|---|---|
| Refund | £420 | £420 |
| VAT on refund | £20 (5/105) | £70 (20/120) |
| Net sales reduction | £400 | £350 |
Using the current rate would overstate the reduction in output VAT by £50.
Part refunds and price adjustments
The same rule applies to:
- discounts given after the sale, such as volume rebates relating to earlier invoices;
- goodwill payments that reduce the price of a past supply;
- returns of goods sold before the change.
Where a credit relates to supplies made both before and after the change, split it by the underlying invoices.
Supplies spanning the change date
A supply that straddles the change, such as a continuous service or a deposit taken before and the balance after, follows the tax point rules. Each tax point keeps the rate in force at that time; there are optional special rules that let some businesses apply the rate in force when the goods or services were actually supplied. Credit notes then follow whichever rate was applied to the part being credited.
In the accounting software
- Keep the old VAT code active, but closed for new sales, so credit notes can be raised against it.
- When raising a credit note, link it to the original invoice so the software picks up the rate automatically.
- Report credit notes at old rates separately in the first periods after the change and review them before each return.
Refunds and VAT schemes
Flat rate scheme users reduce their flat-rate turnover by the refund; cash accounting users adjust when the refund is paid. Neither changes the principle that the original rate governs.