Calculating VAT on discounts

Click on the download button, then open the example invoice and credit note. 

The examples in the downloaded document show the two HMRC-approved methods for accounting for prompt payment discounts. In both cases, VAT is ultimately calculated on the amount the customer actually pays if they take advantage of the discount.

Option 1 – Issue a sales invoice

• An invoice is prepared for the full amount. In this example the amount is £300. 
• The rate of VAT is clearly shown (at 20%)
• The trade discount is calculated at 15% and deducted from the usual price (£300 – £45 = £255)
• The VAT is calculated on the net: £255 x 20% = £51
• The amount payable if the prompt payment discount is not taken is shown (£306), along with the terms of the prompt payment discount: ‘A 3% discount applies if payment is made within seven days of the invoice date.’ 

Option 1 – Issue a credit note

The customer pays pays within seven days and £296.82 is received, therefore a credit note is issued. 

• The rate of VAT is clearly shown (at 20%)
• This is 3% of the net figure on the invoice: £255 x 3% = £7.65
• The VAT is calculated on the net: £7.65 x 20% = £1.53
• This is the amount by which the original invoice has been reduced. The customer paid £296.82 (£306.00 – £9.18).

Option 2: Include further information on the original sales invoice

The invoice is prepared for the full amount of £300 with additional information: 

• The rate of VAT is clearly shown (at 20%)
• The trade discount is calculated at 15% and deducted from the usual price (£300 – £45 =£255)
• The VAT is calculated on the net. £255 x 20% = £51
• The amount payable if the prompt payment discount is not taken is shown (£306), along with the terms of the prompt payment discount: ‘A 3% discount applies if payment is made within seven days of the invoice date. No credit note will be issued. On payment you may only recover the VAT actually paid.’ 

For more assistance with calculating VAT, use our online UK VAT Calculator.