A deposit or advance payment received before goods are delivered or services are performed normally creates a VAT tax point on the day you receive it, so the VAT on that amount belongs on the return covering the date of receipt. A security deposit held against the safe return of hired goods is not payment for a supply and creates no tax point. Since 1 March 2019, a deposit you keep when the customer cancels or fails to turn up stays subject to VAT; only amounts you actually refund can be adjusted.

When does a deposit create a tax point?

Every supply has a basic tax point. For goods it is usually when they are removed or made available to the customer; for services it is when the service is performed. Section 6(4) of the Value Added Tax Act 1994 overrides that date where the supplier issues a VAT invoice or receives a payment first. In that case the supply is treated as taking place when the payment is received, but only to the extent covered by the payment.

HMRC’s VAT guide (VAT Notice 700, paragraph 14.2.3) says most deposits serve primarily as advance payments and create a tax point when you receive them. Its time of supply manual (VATTOS5120) explains that a prepayment or deposit intended to form part of the consideration for an identifiable supply creates a tax point under section 6(4).

Three practical consequences follow:

  • The VAT is due on the return for the period in which the money arrives, not the period in which the job is finished or the final invoice is raised.
  • The deposit is normally treated as VAT inclusive. At the standard rate of 20% the VAT element is one sixth of the amount received (VAT Notice 700, paragraph 7.3.1).
  • The balance has its own tax point. It is the basic tax point unless you invoice or are paid earlier, or you issue a VAT invoice within 14 days after the basic tax point, in which case the invoice date becomes the tax point (section 6(5)).

Notice 700 also says VAT is accounted for in the period in which the tax point occurs, at the rate in force at that time. If you use the cash accounting scheme different rules apply, set out in VAT Notice 731.

Does it make a difference if the deposit is refundable?

Generally not. VATTOS5125 says it is sometimes claimed that a refundable deposit cannot create a tax point, and that this is wrong. HMRC cites tribunal and court decisions where a tax point arose even though the customer could get the money back:

  • Moonraker’s Guest House Ltd: holiday booking deposits, refundable if the room could be relet, created a tax point on receipt (High Court).
  • East Kilbride Golf Club: wholly refundable monthly instalments towards next year’s subscription created tax points when paid.
  • Clowance PLC: timeshare deposits refundable if the lodges were not finished on time still created tax points, because section 6(4) applies to conditional and unconditional contracts alike.

Saying that the money is held in trust until the supply is made does not help either. In Richmond Theatre Management Ltd the High Court held that even a genuine trust arrangement for advance ticket sales would still amount to a payment for VAT purposes (VATTOS5140).

Which deposits do not create a tax point?

A payment only creates a tax point if it is made in respect of a supply. The main exceptions are:

  • Security deposits. Money taken to secure the safe return of hired goods, refunded on return or kept to compensate for loss or damage, is not consideration for a supply (Notice 700, paragraph 14.2.3; VATTOS5135). A tax point can arise if hire charges are later set against the deposit before the end of the hire.
  • Stakeholder deposits on property. Where a third party holds a deposit as stakeholder rather than as the seller’s agent, there is no tax point until the money is released to the seller.
  • No identifiable supply. Following the Court of Justice decision in Bupa Hospitals, the future supply must be sufficiently identified. HMRC acknowledges two unusual tribunal cases where no tax point arose: a Ferrari dealer’s waiting list deposit that was only an agreement to make an agreement (Nigel Mansell Sports Cars Ltd), and school fees instalments towards a club membership the pupil might never take up (Old Chigwellians Club) (VATTOS5130).
  • Accidental overpayments. In British Telecommunications PLC the Court of Appeal accepted that accidental overpayments were not made in respect of a supply (VATTOS5110).

What happens when a customer cancels and you keep the deposit?

This changed on 1 March 2019. Revenue and Customs Brief 13 (2018) withdrew the old practice of treating many retained payments for unused services and uncollected goods as outside the scope of VAT. Following the Court of Justice decisions in Air France KLM and Firin OOD, HMRC’s position is that VAT is due on all retained payments for unfulfilled supplies, with no adjustment or refund of VAT for the amount kept.

Notice 700, paragraph 8.13.1, now says VAT is due on all charges, deposits and fees that are full or part payments for a supply. A payment cannot be reclassified as compensation once it is known that the customer will not take up the supply. The brief’s example is a hotel room paid for in advance with no right to a refund: the hotel accounts for VAT when it takes the payment and cannot reduce it if the guest cancels or does not arrive.

Where a business only takes card details as a guarantee and charges the card later, VAT is due when the payment is taken. The brief also confirms that businesses which never treated retained payments as outside the scope cannot now adjust earlier periods, because they made no error.

What if you refund the deposit?

Notice 700, paragraph 8.13.1, says that if you refund the payment you can reclaim the VAT you accounted for in your next return. The High Court in Moonraker’s took the same view: where VAT has been accounted for on a deposit and the supply does not happen, the VAT can be adjusted at that point. If only part of the deposit is refunded, only the VAT on the refunded part comes back; the VAT on any amount you keep stays due.

Keep the paperwork that shows when and how much was refunded, and make the adjustment in the period of the refund rather than reopening the original return. Your VAT control account should show the deposit VAT and the later reversal as separate entries.

How does this work in practice?

Illustration only. A kitchen fitter on calendar quarters takes a deposit of £1,200 including VAT on 20 March. The job is finished on 15 May and the invoice for the £4,800 balance is issued on 20 May.

Event Tax point VAT Return
Deposit received 20 March 20 March (payment before basic tax point) £200 (one sixth of £1,200) Quarter to 31 March
Balance invoiced 20 May 20 May (invoice within 14 days of completion) £800 (one sixth of £4,800) Quarter to 30 June

If the customer had cancelled in April and the fitter kept the deposit under the contract, the £200 would stay on the March return with no adjustment. If the fitter had refunded the full £1,200, the £200 would be reclaimed on the next return after the refund.

What about the customer who pays the deposit?

A VAT registered customer can treat the VAT on a deposit as input tax in the period of the supplier’s tax point, provided it holds the evidence, usually a VAT invoice for the deposit. Notice 700, paragraph 10.5, says that where the evidence arrives later, the claim goes on the return for the period in which it is received. If the deposit is later refunded with a credit note, the customer must reduce its input tax.

What mistakes come up most often?

  • Waiting for the final invoice before declaring VAT on deposits, which understates earlier returns and invites assessments if found in an HMRC compliance check.
  • Treating cancellation deposits as outside the scope of VAT under the pre 2019 practice.
  • Calling an advance payment a security deposit when it is in fact set against the price.
  • Reversing the VAT on a deposit that was kept rather than refunded.
  • Forgetting that a booking fee charged by an agent is consideration for the booking service, so it stays taxable even if the customer never uses the hotel room (Notice 700, paragraph 8.13.1).

Errors found on past returns are corrected under the normal error rules, explained in correcting VAT errors, and are subject to the four year cap on VAT claims.

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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.