VAT on car hire: deposits, excess, cancellation fees and long hires

VAT on car hire looks simple until the money stops arriving in one piece. A deposit in March, a balance in May, a damage charge in June and a parking fine in August can each be treated differently, and a long hire to a visitor from abroad has its own rule. This guide sets out how HMRC's published guidance treats each of those payments, with every point linked to its source. It is general information, not tax advice: VAT turns on the facts of each transaction and the wording of your contracts, so confirm your own treatment with your accountant. Where HMRC's guidance does not settle a point, the guide says so.

1. Registration: the £90,000 test, and registering early

You must register for VAT if your total taxable turnover for the last 12 months goes over £90,000, within 30 days of the end of the month in which you went over. You must also register if you expect your taxable turnover to go over £90,000 in the next 30 days alone, by the end of that 30-day period (GOV.UK: register for VAT). The 12-month test rolls month by month, so a busy summer is the usual trigger for a hire business. How the decision fits with setting up the business is in the start-up guide's section on the entity.

You can also choose to register below £90,000, which HMRC calls voluntary registration (GOV.UK: voluntary registration). For a hire business the reason to consider it is the fleet. As a general rule VAT on buying a car cannot be recovered, but it can be recovered in full on a qualifying car you intend to use primarily for self-drive hire (HMRC VAT Notice 700/64, sections 3.1 and 3.4). If you later put that car to a use that would not qualify, such as taking it off the fleet for private use, you must account for output tax on its value at the time (VAT Notice 700/64, section 3.10).

2. The rate: is car hire VAT exempt?

No HMRC page names self-drive hire as exempt, zero-rated or reduced-rated. The standard rate is 20% and applies to most goods and services (GOV.UK: VAT rates). HMRC's guide to rates on different goods and services lists the transport and vehicle supplies taxed differently, such as passenger transport in vehicles carrying 10 or more passengers; self-drive hire of a car or van is not among them, and HMRC says the guide is not a complete list (HMRC: rates of VAT on different goods and services). Once registered, plan on 20% on the hire and the extras sold with it, and ask your accountant about anything unusual in your range.

Your advertised consumer prices are therefore VAT-inclusive, and your margin is what remains after the VAT comes out. Business customers will want a VAT invoice: HMRC says that whenever you make a standard-rated supply to another VAT-registered person you must give them one, normally within 30 days of the tax point, and because you usually cannot tell who is registered, in practice you issue one to any customer who asks (HMRC VAT Notice 700, paragraphs 16.2.1 and 16.2.3).

3. Tax points: each payment is its own VAT event

For a service the basic tax point is when it is performed, but a payment received earlier creates a tax point on the date you receive it (VAT Notice 700, paragraphs 14.2.1 and 14.2.2). HMRC adds that most deposits serve primarily as advance payments and create a tax point when received (VAT Notice 700, paragraph 14.2.3). A typical booking looks like this:

So the VAT on a summer hire booked in winter is due in the winter quarter, on the deposit, before the car has turned a wheel, and your records need each payment against its booking so the return matches the bank. Glovebox issues a VAT invoice for each payment a business customer makes and a credit note when you refund, and exports the figures for your VAT return; the UK features page lists the rest.

4. Security deposits, retained deposits and cancellation charges

Refundable security deposits

HMRC's own example fits hire exactly: if you take a deposit as security for the safe return of goods you have hired out, and it is either refunded when they come back safely or forfeited to compensate you for loss or damage, no tax point is created (VAT Notice 700, paragraph 14.2.3). That depends on the deposit genuinely being security, so the agreement should call it a security deposit, say it is refunded on safe return, and keep it separate from the hire price. How card holds differ from taken deposits is covered in deposits, excess and damage charges.

Booking deposits you keep when a customer cancels

VAT is due on deposits that are full or part payments for a supply, and if you keep a payment for a supply your customer fails to take up, VAT is due on the amount paid: it cannot be reclassified as outside the scope because the supply went unused. If you refund it, you can reclaim the VAT in your next return (VAT Notice 700, paragraph 8.13.1). HMRC's manual says that since 1 March 2019 VAT on an advance payment can be adjusted only if, and only to the extent that, it is refunded (HMRC manual VATSC05822). Refund half, adjust half.

Cancellation charges billed afterwards

Where a customer cancels and you charge a fee to compensate you for having made the supply available, HMRC says that will normally be further consideration for the supply, even if described as damages. The exception is a fee so high it is clearly punitive, designed to prevent a breach rather than compensate for lost income, which HMRC treats as outside the scope (HMRC manual VATSC05930). A punitive cancellation fee is also likely to be unfair under consumer law, as the car hire agreement guide explains, so the working assumption is that cancellation charges carry VAT. Confirm yours with your accountant.

5. Excess, damage, late returns and fuel

HMRC's manual uses car hire as its own worked example. A late-return charge, where the customer knows an extra charge will be made and how it is calculated, is subject to VAT because it is an additional hire fee. A fee charged when the customer writes the car off is not further consideration for the hire, because the hire company never agreed that the customer could write it off, so the reciprocity a supply needs is missing (HMRC manual VATSC05910). That gives a working map:

• Late return or extra days. More use of the car, so further consideration for the hire, at 20%.
• Damage recharged up to the excess. The write-off example and the forfeited security deposit example both point to compensation outside the scope of VAT. HMRC's pages address those two cases, not every scratch and dent, so confirm with your accountant that your damage recharges follow the same treatment.
• Damage waiver or excess reduction you sell. This is a price paid for something, not compensation. Whether it is part of the hire at 20% or exempt insurance depends on whether it is genuine insurance covering the customer's own risk (HMRC VAT Notice 701/36, paragraphs 11.1 to 11.3). The insurance side is in insurance for a car hire business.
• Fuel. HMRC lists fuel for business use as usually standard-rated (HMRC: rates of VAT on different goods and services), and the hire is standard-rated too, so expect 20% on a refuelling charge. Confirm the treatment of electric vehicle charging fees with your accountant.

6. Fines, zone charges and tolls you pass on

A true fine or penalty is not consideration for a supply and is outside the scope of VAT; HMRC's examples include money levied to penalise parking on yellow lines (HMRC manual VATSC06140). Congestion charges run by public authorities under statute are outside the scope (HMRC manual VATGPB8665), as are tolls operated by public authorities, while privately operated tolls are standard-rated (HMRC: rates of VAT on different goods and services).

That settles the charge itself, not your recharge. If you transfer liability, the notice goes to the hirer and nothing passes through your books. If you pay and recharge, the amount can be left out of your VAT calculation only as a disbursement, and HMRC lists eight conditions that must all be met, including that you paid as your customer's agent, that your customer was responsible for paying the third party and authorised you to pay, and that you recover only the exact amount you paid (VAT Notice 700, paragraph 25.1.1). A penalty addressed to you as keeper may fail the condition that your customer was responsible for it, and an admin fee on top is not the exact amount paid. HMRC's published guidance does not address hire-firm recharges of fines directly, so agree the treatment with your accountant. The contract side is in ULEZ, clean air zones and tolls and PCNs and fines on hire cars.

7. The Flat Rate Scheme: simpler, but no VAT back on the fleet

Under the Flat Rate Scheme you pay HMRC a fixed percentage of your VAT-inclusive turnover and cannot reclaim VAT on purchases, except certain capital assets over £2,000. You can join if you expect VAT taxable turnover of £150,000 or less, excluding VAT, in the next 12 months; you get a 1% discount in your first year of registration; a limited cost business pays 16.5%; and you must leave if turnover on the anniversary of joining was more than £230,000 including VAT, or you expect it to be (GOV.UK: VAT Flat Rate Scheme). HMRC's table lists 9.5% for "hiring or renting goods" (GOV.UK: work out your flat rate); confirm with your accountant which category HMRC will accept for your business.

The catch is in the scheme notice: capital goods bought to generate income by being hired out are not capital expenditure goods, no matter how much they cost (HMRC VAT Notice 733, paragraph 15.7). So the £2,000 reclaim does not reach the vehicles you hire out. On the standard scheme a qualifying self-drive hire car carries full input tax recovery; on the Flat Rate Scheme it does not. Take a £500 hire plus £100 VAT: on the standard scheme you pay £100 less the VAT on your costs; at 9.5%, if that rate applied, you pay £57 and reclaim nothing on running costs. Which comes out ahead depends on your costs and fleet plan, and the fleet utilisation calculator helps with the revenue side.

8. Long hires to customers from abroad

HMRC's examples of a means of transport include cars, trucks, touring caravans and trailers, and hiring one out has its own place of supply rules. A short-term hire is a continuous period of not more than 30 days (90 for a vessel), and for business and consumer customers alike it is supplied where the vehicle is put at the customer's disposal, which is where the keys are handed over (HMRC VAT Notice 741A, sections 8.2 to 8.6). Collect in the UK, and it is a UK supply.

A long-term hire is supplied where the customer belongs, for consumers and businesses alike (VAT Notice 741A, sections 8.7 and 8.8). That looks like a route out of UK VAT for a visitor's eight-week touring hire, but the use and enjoyment rules override it: where a hire would be supplied outside the UK but the goods are effectively used and enjoyed here, UK VAT is due on the part used here (VAT Notice 741A, sections 8.9, 13.1 and 13.2). A visitor touring Britain uses the car here, so in most cases UK VAT stays on the bill.

Back-to-back contracts for the same vehicle with two days or less between them are looked at together, and an extension that takes a short hire past 30 days moves it into the long-term rule unless the circumstances were outside the parties' control (VAT Notice 741A, section 8.5). Hires where the vehicle genuinely leaves the UK, and apportionment, are for your accountant.

The checklist

1. Track rolling 12-month taxable turnover against the £90,000 threshold, and the 30-day forward test in peak season.
2. Decide with your accountant whether to register early, with the fleet purchase plan in front of you.
3. Price consumer hires VAT-inclusive at 20%, and issue a VAT invoice to any business customer who asks.
4. Account for VAT on each booking deposit and balance in the period you receive it.
5. Write security deposits as refundable security, separate from the hire price.
6. Treat retained booking deposits, cancellation charges and late-return charges as carrying VAT unless your accountant says otherwise.
7. Agree the treatment of damage recharges, damage waivers, fuel and recharged fines with your accountant before writing the terms.
8. Before joining the Flat Rate Scheme, cost what losing input tax on the fleet means.
9. Count hire days carefully on long hires, and keep UK VAT on hires used in the UK.

Straight answers