How will the VAT changes to lease termination payments impact commercial property landlords?

In September, HMRC announced that it had changed its policy and that lease termination payments and most other payments described as compensation would be subject to VAT. To much surprise they also stated that this apparent change in policy would be applied retrospectively, leaving businesses with potential VAT costs going back four years. The focus of HMRC’s change of policy is primarily the telecoms sector and charges applied when customers exit one contract and enter into another to upgrade a mobile telephone package or handset which have typically not been subject to VAT, in the hands of the telecoms provider.

Impact on the real estate sector

To date HMRC have not directly commented on the impact on the real estate sector. However, there is a real risk that HMRC will also seek to levy VAT on lease termination payments both retrospectively and going forwards. We expect there to be litigation by businesses across many impacted sectors, if HMRC do seek to levy VAT retrospectively where they clearly changed their published policy. We also expect that HMRC would not seek to apply penalties but again there has been no guidance from them on this point, leaving businesses potentially looking at penalties of up to 30 per cent in addition to the VAT cost.

At a time when many landlords are struggling to collect rents or are entering into discussions over leases with tenants this is at best an unwelcome complication and at worst potentially a significant cost exposure.

What can be done?

Where landlords are currently negotiating lease exit payments advice should be taken as to whether to apply VAT post HMRC’s policy change in September 2020. For new leases being entered, landlords should review their VAT clauses in contracts to make sure that they have the right to charge VAT. For existing leases these should be reviewed to identify any potential exposures.

Where landlords have opted to tax and their tenants are able to recover VAT, in most cases this change in HMRC policy should not create a VAT cost, if correctly applied. However, where landlords have opted to tax, but their client is VAT adverse, such as the financial services and not for profit sectors there could be resistance and challenge to VAT being applied. Landlords should also be mindful of circumstances where their tenant has vacated the property and gone into liquidation or could about to do so and the ability to apply VAT.

For more information on how the changes to lease termination payments could affect you, please contact Ian Carpenter.