# VAT & the annual cost of settlement discounts

timgriff
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**55**
Sorry to keep dragging this topic up but something that’s been bugging me about the ‘true’ cost of a settlement discount is what about the benefit of the VAT savings made from a settlement discount?

Say the invoice is £1000 and has a 3% settlement discount. The VAT is charged on £970 which would be £169.75. This is opposed to £175 being charged on £1000 if no discount was offered.

So therefore the VAT liability that has to be paid to HMRC (output tax) has reduced by £5.25. Hence, the future cash flow is up by £5.25.

Now if we are to work out the ‘true cost’ of a settlement discount why wouldn’t we factor this benefit in with the annual APR? ….or am I missing something and being pedantic??? Is this just too complex?

Another thing I‘ve noticed as well:

- By receiving the money more quickly the business has improved cash flow and therefore has the opportunity to gain interest on that money. So why don’t we factor this in to the true cost of the discount?

My head hurts now!!

Say the invoice is £1000 and has a 3% settlement discount. The VAT is charged on £970 which would be £169.75. This is opposed to £175 being charged on £1000 if no discount was offered.

So therefore the VAT liability that has to be paid to HMRC (output tax) has reduced by £5.25. Hence, the future cash flow is up by £5.25.

Now if we are to work out the ‘true cost’ of a settlement discount why wouldn’t we factor this benefit in with the annual APR? ….or am I missing something and being pedantic??? Is this just too complex?

Another thing I‘ve noticed as well:

- By receiving the money more quickly the business has improved cash flow and therefore has the opportunity to gain interest on that money. So why don’t we factor this in to the true cost of the discount?

My head hurts now!!

## Comments

2,492I've not done annual cost of settlement discounts yet; however when a invoice is issued with a settlement discount on it the VAT is calculated at the discounted rate regardless whether you take this settlement discount or not.

So say invoice X was for £100 + VAT, but you had a settlement discount of 1% (VAT on the invoice without a settlement discount would be £17.50) but since there is a settlement discount the VAT is calculated on £99 (£100 - 1%) so the VAT on the invoice would show as £17.33 (£99 + VAT) but the invoice would actually show

Net £100

VAT £17.33

Gross £117.33

With only £116.33 if settlement discount is taken..

Hope this makes sense; it's early..!

55Hi, thanks for replying... So in essence regardless of whether the discount is taken or not the Output VAT has reduced by 17pence (in your example 17.33 VAT will be collected as opposed to 17.50 if no discount was offered). The company has therefore saved 17p which they don't have to pay to HMRC at the next tax return. Although 17p is not a lot, when your talking £000's of invoices, it will add up.

So where am I going with this? Well, when we are asked to work out the true annualised cost of a settlement discount, the AAT are being quite particular about things like compound interest so why not be picky about other costs/benefits that would ultimately effect the APR??

The APR is often high (e.g. 40%) as the discounted amount is the price we pay for having the money earlier. But a true analysis will include the VAT saving and the fact that we've got £xx earlier means we can make interest on that money for say 20 days more than if we didn't offer a discount (if you see what i mean). Surely these benefits have to be considered when calculating the

costof a settlement discount??