VAT on property has always been a tricky subject. In some circumstances, such as residential letting, the supply that is being made is always exempt. Other supplies, for example, off-street car parking, are always subject to VAT.
But it isn’t always that clear-cut and it can prove perplexing, in particular for commercial property where the supplier has the ‘option to tax’ (providing it does not fall foul of HMRC’s anti-avoidance laws). And even more confusingly, when a lease is exited, then there could be further payments due that may not fall within the scope of VAT at all.
A typical payment at the end of the lease that is sometimes outside the scope of VAT is for dilapidations. Dilapidations are payments made from the exiting tenant to a landlord at the end of a lease, to recompense the landlord for essential repairs needed to bring a building back up to its former condition at the end of a tenancy.
The tenant often has the obligation to leave the property in the same condition it was in when the lease was entered, accounting for a reasonable amount of wear and tear. When a dilapidations payment is due, it is generally because the tenant has not met these requirements under the terms of the lease or ‘made good’ before leaving the building.
Dilapidations were accepted as beyond the scope of VAT as compensation in almost all circumstances, until HMRC abruptly changed its guidance on ‘termination payments’ following a VAT court case about (of all things) mobile phone contracts. In September 2020, guidance was issued by HMRC – and soon challenged – that looked set to make any termination payments follow the same VAT liability of the main supply (in this case, either a taxable or exempt lease).
Thankfully, after intense lobbying from various interested parties, HMRC suspended the guidance in January 2021 and has since clarified in a recently published brief (RCB 2/22) explaining how and when this may apply to exiting a lease and any viable dilapidation payments. And in most cases, we are now back to the position of these being outside the scope of VAT as compensation.
So, what does HMRC’s guidance say? More importantly, what are the potential pitfalls to watch out for?
In most scenarios, HMRC’s policy is to treat dilapidations payments as outside the scope of VAT. However, it reserves the right to depart from this policy if ‘in individual cases [it] found evidence of value shifting from rent to dilapidation payment to avoid accounting for VAT’.
This is a pragmatic policy from HMRC, and we welcome the relative certainty in an otherwise complex field.
While VAT on property matters may seem confusing, it’s nothing our expert team can’t guide you through. If you want to discuss this or any other VAT and property query, please contact our team.