One exception is preserved: genuine security deposits (held against the safe return of hired goods, not as a payment towards a supply) remain outside the scope of VAT. The distinction is the purpose: payment on account, VAT applies; security against damage or non-return, no VAT. If the contract is later cancelled and the deposit is actually refunded, the VAT previously declared can be adjusted under Regulation 38.
This is one of the most overlooked rule changes of the past few years, and we still see businesses applying the pre-2019 treatment. The change came from HMRC Revenue and Customs Brief 13 (2018) and took effect on 1 March 2019. Hospitality is the most exposed sector, but anything that takes deposits (events, weddings, training providers, fitness studios, beauty salons, professional services) is in scope. If you took the deposit and the customer never showed, the post-2019 default is that VAT is due, not that the supply was cancelled.
- Treating a no-show deposit as outside the scope. This was the pre-2019 position and is still the default mental model in many businesses. Since 1 March 2019, a deposit retained because the customer cancelled or did not turn up remains consideration, and VAT stays due. Apply the old rule today and an HMRC check will pick it up.
- Confusing a security deposit with a payment on account. A deposit held against the safe return of hired equipment is outside the scope of VAT. A deposit set against the eventual invoice is a payment on account and creates a tax point on receipt. The contract wording decides the treatment, not the receipt label.
- Reclaiming the VAT when the customer cancels but you keep the money. If you have declared VAT on a deposit and the customer cancels, the VAT can only be adjusted (under Regulation 38) to the extent you actually refund. Keep all the deposit, keep all the VAT. The cancellation alone is not the trigger.
- Forgetting the tax point on receipt. Section 6(4) of the VAT Act 1994 creates a tax point at the earlier of the invoice date or the receipt of payment. A "non-refundable" deposit accounts for VAT at the time it was received, regardless of whether the supply later happens. Backdating the VAT after a cancellation creates late payment penalties.
- Issuing a refund without amending the VAT records. When a deposit is refunded, the supplier should issue a credit note and adjust the VAT under Regulation 38 in the period the refund is made. Failing to do so leaves the output VAT on HMRC's books and the refund coming out of post-VAT cash.
What changed in 2019, and why
Before 1 March 2019, HMRC's working position was that a deposit retained when a customer cancelled or failed to take up a supply could be treated as compensation, and so outside the scope of VAT. That position rested on the European Court's decision in Société thermale d'Eugénie-les-Bains (C-277/05), which characterised forfeited hotel deposits as fixed compensation rather than payment for a supply.
Two later Court of Justice judgments changed the picture. Air France-KLM (C-250/14) held that VAT was due on non-refundable airline tickets where the passenger did not fly, because the customer had paid for the right to benefit from a service whether or not they used it. Firin OOD (C-107/13) reinforced the point that VAT due on a prepayment cannot simply be reversed unless the payment itself is refunded.
HMRC reflected those judgments in Revenue and Customs Brief 13 (2018). From 1 March 2019, deposits retained on a customer no-show or cancellation became consideration for the underlying supply, taxable in full at the rate applicable to that supply. The "compensation" treatment effectively disappeared for prepayments tied to an identifiable supply.
Payment on account vs security deposit: the distinction that decides everything
The Brief 13 rule applies to payments on account, that is, money paid in advance that is intended to count towards the eventual price of a supply. It does not apply to genuine security deposits, which are a different beast and remain outside the scope of VAT.
The line between the two is in HMRC's manual at VATSC06120 and VATTOS5135, and turns on what the deposit is actually for:
- Payment on account. The deposit will be applied against the final invoice. If the customer pays £100 deposit on a £400 service, the balance owed is £300. The £100 was always part of the consideration. VAT is due on receipt under section 6(4) of the VAT Act 1994, and stays due if the deposit is retained on cancellation.
- Security deposit. The deposit is held to protect against a risk (damage to hired equipment, late return, breach of a specific obligation) and is intended to be refunded in full if the risk does not materialise. No supply is paid for at deposit stage, so there is no VAT. Even if the deposit is later retained because damage occurred, the retained portion is compensation for the damage, not consideration for a supply.
In practice, the contract wording and the actual mechanics decide which one applies. Labelling a payment-on-account as a "security deposit" on the receipt does not change its substance. HMRC and the tribunal will look at whether the deposit was always destined to be applied against the price.
When the customer cancels: what to do with the VAT
The Brief 13 framework is straightforward once the deposit has been correctly classified at the outset. For a payment on account:
- You declare VAT on receipt of the deposit. Tax point under section 6(4): the earlier of invoice date and receipt of payment. The VAT goes into the return for the period in which the deposit was received.
- If the customer cancels and you retain the full deposit: the VAT stays declared, no adjustment. The retained money is consideration for the right to benefit, exercised or not.
- If you refund the full deposit: issue a credit note, adjust the output VAT under Regulation 38 in the period the refund is made. The original tax point still stood, the adjustment unwinds it once the cash leaves.
- If you refund part of the deposit: adjust the VAT to the extent of the refund. Retain £60 of a £100 deposit, refund £40, adjust VAT on the £40 only.
The expensive mistake on the supplier side is treating the cancellation itself as the trigger for the VAT adjustment. It is not. The refund is the trigger. Until the money actually moves back, the VAT remains payable to HMRC. This catches businesses that write off non-refundable deposits in their accounting system as if no supply had ever happened, and then forget to remit the VAT that was tied to those receipts.
Worried that your business has been treating no-show deposits as outside the scope since 2019? Our VAT Compliance Audit takes a clear look.
Sector examples: where this matters most
The Brief 13 rule applies across the economy, but a handful of sectors carry the bulk of the exposure because deposits are a normal part of how they trade:
- Hotels and B&Bs. The classic Brief 13 case. A guest books a room, pays a deposit (often the first night), then does not arrive. The hotel keeps the deposit. Post-2019, that retained amount is consideration for the room and carries VAT at the standard rate (assuming the hotel is VAT-registered).
- Weddings and events venues. Deposits for receptions, hire of function rooms, catering packages. Cancellations are frequent and amounts are often substantial. VAT is due on the deposit when paid and stays due on any portion retained.
- Training providers and course operators. Pre-paid course fees retained when delegates do not attend are caught by the same rule. VAT due on receipt, stays due on no-show.
- Beauty, fitness, and personal services. Salons that require a deposit at booking, gyms that charge upfront for blocks of classes, personal trainers taking advance payment, all sit in the same framework.
- Professional services with retainers. Where a retainer is genuinely a payment on account for future services, the rule applies. Where it is a fee for being on call, separate questions arise (it is normally a supply in its own right, taxable when received, with no real interaction with the Brief 13 rule).
The common pattern is that the VAT exposure builds up quietly. Each individual no-show feels small, the deposit is often modest, the cancellation is administratively annoying, and the VAT consequence is the last thing the business is thinking about. Over twelve months and several hundred no-shows in a busy hospitality business, the underdeclaration can be material, and it is exactly the kind of pattern that an HMRC compliance check will surface from the daily takings records.
When you might need expert VAT advisory
The Brief 13 framework is conceptually clean but the application gets messy at the margins. In practice, the situations below are where a senior specialist's read makes a real difference:
- You're reviewing historic deposit treatment and worried that the pre-2019 approach has continued in your books past 1 March 2019, and you want a clear-eyed view of the disclosure position
- Your business uses mixed deposits: a single "deposit" that is part security, part payment on account, and you need to split the VAT treatment correctly
- You operate in a sector where the cancellation policy is bespoke per booking (sliding-scale refunds, partial refunds based on lead time), and you want a clean Regulation 38 process for each scenario
- HMRC has raised an assessment on deposit-related output VAT and you want to test whether the underlying classification of the deposits is defensible
- You're structuring new commercial terms (a wedding package, a course, a retainer arrangement) and want the deposit treatment clear before the contracts go out
- You're an accountant taking on a hospitality or service client and want a sense-check on the deposit accounting before the next return is filed
Whether you're a business owner or an accountant working on a client case, we focus on the VAT questions where extra expertise pays off, and we work in plain English.