VAT is due on the consideration actually paid, so a genuine reduction in price reduces the VAT. Discounts given up front simply reduce the taxable value; prompt payment discounts reduce it only if the customer takes them up; and a price cut agreed after the invoice must be evidenced by a credit note issued within 14 days of the refund, with both supplier and customer adjusting VAT in the period the reduction happens.

How does a discount given at the time of sale affect VAT?

If the price is reduced before or at the time of supply, the reduced price is the consideration and VAT is charged on it. HMRC’s VAT Valuation manual (VATVAL08600) confirms this for trade discounts, staff discounts and cash discounts: the only consideration is the money actually paid, so section 19(2) of the VAT Act 1994 applies to the lower sum. No credit note is needed because the invoice is raised at the discounted price.

The same manual lists common retail and manufacturer arrangements. Some, such as off invoice price promotions, simply follow the liability of the goods as a price reduction. Others, such as payments for prime shelf positions or business protection deals, are taxable supplies by the customer to the manufacturer and are invoiced the other way, rather than being discounts at all.

How do prompt payment discounts work now?

A prompt payment discount reduces the price if the customer pays within a set time. Under paragraph 4 of Schedule 6 to the VAT Act 1994, where the terms allow such a discount, payment is not by instalments, and the customer pays in line with the terms so the discount is realised, the consideration is the discounted price paid.

VATVAL08500 explains the history. Before the change, businesses could account for VAT on the discounted amount even when the customer paid in full. That ended from 1 May 2014 for broadcasting and telecommunications businesses with no obligation to issue a VAT invoice, and from 1 April 2015 for all other businesses. Suppliers now account for VAT on the amount actually paid, and customers may recover only the VAT actually paid.

Suppliers choose one of two methods before invoicing (VATVAL08500; VAT Notice 700 paragraph 18.2.2):

  1. Invoice the full price and issue a credit note if the discount is taken up.
  2. Invoice the full price with the discount terms on the invoice, including the time by which the discounted price must be paid, and a statement that the customer can only recover as input tax the VAT actually paid. HMRC recommends this wording: “A discount of X% of the full price applies if payment is made within Y days of the invoice date. No credit note will be issued. Following payment you must ensure you have only recovered the VAT actually paid.” The invoice plus evidence of payment, such as a bank statement, then supports the adjustment.

A short payment made outside the discount terms is not a prompt payment discount. VATVAL08500 says VAT remains due on the full invoiced amount, and any unpaid balance is dealt with as a bad debt unless a price adjustment is later agreed.

What does a prompt payment discount look like in numbers?

Illustration only. A supplier invoices £1,000 plus £200 VAT, offering 5% off if paid within 14 days, using the “no credit note will be issued” wording.

Customer action Amount paid Supplier output tax Customer input tax
Pays within 14 days £950 plus £190 VAT £190 £190
Pays after 14 days £1,000 plus £200 VAT £200 £200

If the customer first records the full £200 and later pays the discounted sum, VATVAL08500 says it must reduce its input tax when it pays, keeping the invoice and payment evidence.

When does a later price reduction change the VAT?

Regulation 38 of the VAT Regulations 1995 requires both supplier and customer to adjust their VAT accounts where the consideration for a supply goes up or down after the event and the VAT charged changes accordingly (VATSC06630). Typical cases are contingent discounts such as volume rebates, goods returned under hire purchase, and a reduced price agreed for defective goods. The change can happen years after the supply.

Since 1 September 2019 the timing rules are strict (VATSC06635; Notice 700 paragraph 18.2.6):

  • A decrease in consideration happens when the supplier actually refunds the customer, or offsets the reduction against a debt the customer owes. A credit note must be issued within 14 days of that refund.
  • An increase in consideration happens when supplier and customer agree it. A debit note must be issued within 14 days of the agreement.
  • The VAT adjustment goes in the return for the period in which the increase or decrease occurs, and a VAT registered customer must reduce its input tax by the same amount.
  • If the change happens in the same VAT period as the original supply, the invoice is simply adjusted in that period and regulation 38 does not apply.

Missing the 14 day window or the right period is an error, to be corrected under the normal rules in VAT Notice 700/45; see correcting VAT errors.

What must a valid credit note show?

Notice 700 paragraph 18.2.3 says a credit note must reflect a genuine mistake, overcharge or agreed reduction, give value to the customer, and show:

  • an identifying number and date of issue
  • the supplier’s name, address and VAT registration number
  • the customer’s name and address
  • a description identifying the goods or services credited
  • the quantity and amount for each description
  • the total credited excluding VAT
  • the rate and amount of VAT credited, in sterling
  • the number and date of the original VAT invoice

The VAT rate is the rate in force at the tax point of the original supply (paragraph 18.2.5). Credits for zero rated or exempt items must be totalled separately (paragraph 18.2.4).

Where the customer can reclaim all the VAT, supplier and customer may agree not to adjust the VAT (paragraph 18.2.1). The credit note should then say “This is not a credit note for VAT”, though both sides still adjust their records of outputs and inputs.

When is a credit note the wrong tool?

VATREC13100 lists situations outside regulation 38, which must be dealt with through error correction and claims instead:

  • the invoiced supply never took place
  • VAT should not have been charged at all, for example on an exempt or zero rated supply
  • the wrong rate was charged but the underlying price has not changed
  • the invoice simply misstated the VAT

Regulation 38 also cannot be used for unpaid debts (VATSC06630). Those fall under bad debt relief, with its own conditions in VAT Notice 700/18; see bad debts in accounting and tax. VATREC13120 summarises the tribunal principles that a credit note must be issued in good faith and not for a bad debt.

Returned goods replaced with similar goods are covered by Notice 700 paragraph 18.3: the original VAT can stand if the replacement is free, or it can be cancelled by credit note and VAT charged on the replacement.

What mistakes are most common?

  • Issuing a credit note before refunding. Since 2019 a decrease only occurs when the money is refunded or offset.
  • Backdating adjustments to the original invoice period rather than the period of the refund.
  • Customers keeping the full input tax after taking a prompt payment discount, which HMRC checks against bank records.
  • Using credit notes to fix a wrong VAT rate instead of the error correction rules.
  • Not posting both sides. Credit notes issued and received should flow through the VAT control account so the return reflects them.

Credit notes around a VAT period end are a common focus of a HMRC VAT compliance check.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.