Court ruling adds to doubts about HMRC’s VAT policy on early termination fees

In September 2020, HMRC issued a brief announcing a controversial new policy on the VAT position of early termination fees and compensation payments. Having generally accepted in the past that such amounts were not subject to VAT, HMRC formed the view (based on two European court judgments in C-295/17 MEO and C-43/19 Vodafone Portugal that charges made to customers who withdraw from agreements are payment for the supply of goods or services which the customer has contracted for. Therefore, HMRC said they were subject to VAT, even if they are described as compensation or damages.

HMRC proposed to apply this interpretation retrospectively, but its guidance gave few firm examples of precisely what would be affected. This raised concerns that it would apply VAT to a wide range of charges and many organisations could face backdated VAT bills. Among those potentially affected were certain property related fees, such as payments for dilapidations or to exercise a break clause in the lease. Faced with strong criticism of its stance from taxpayers, HMRC agreed not to implement the new policy while it discussed its precise scope with stakeholders and promised to issue further guidance in early 2021 once that review was complete. Now, almost 18 months after the policy was first announced, it remains suspended while talks continue.

The position has now been complicated further by a recent Court of Session decision in Ventgrove v Kuehne & Nagel; a property dispute between a landlord and its tenant, which casts doubt over HMRC’s rationale behind its new policy.

The case concerned a tenant’s decision to exercise a break clause at the halfway point of their lease of a commercial property. The tenant paid the landlord the break clause fee of £112,500 stipulated in the lease. However, the landlord argued that this was not sufficient to trigger the break clause because, as the property was subject to an ‘option to tax’ for VAT purposes, the terms of HMRC’s brief meant that the tenant should also have paid VAT of £22,500 on top of the fee.

The court has disagreed, finding that VAT was not due on the payment, so the lease had been validly terminated. This was primarily because, on the date the break clause was invoked by the tenant, the policy in HMRC’s brief was suspended, so its proposed policy did not apply in this case.

Perhaps more tellingly, the court has also stated that the MEO and Vodafone Portugal judgments relied on by HMRC do not apply to the facts of the Ventgrove case. Those cases concern early termination penalty fees payable where a customer breached a mobile phone or TV/telecoms and broadband contract by failing to complete a minimum period for using that service. This is different from the break clause in this property lease, which gave the tenant a contractual right to pay to end the lease after a minimum period had been completed.

HMRC’s brief has already been criticised by stakeholders for overstretching the logic of MEO and Vodafone Portugal to apply VAT to a wider variety of compensation payments and penalty charges than those judgments would appear to cover. The Court of Session’s decision would now seem to support that criticism.

HMRC has not yet responded to this latest development, and is unlikely to completely abandon its new policy as a result. However, the Ventgrove decision gives opponents of the policy ammunition to argue that VAT is not chargeable on property break clauses or other termination payments that are part of a contract, rather than arising from a breach of a contract. HMRC will have to think more carefully about the legal basis for its policy before publishing its promised guidance, so it may take even longer before this protracted disagreement is finally resolved.