By Adam Cutler, director in Crowe’s VAT and Customs Duty Services team (www.crowe.co.uk)
Changes to the way we live and work have meant some commercial premises are no longer viable locations for catering and hospitality operators. Terminating leases early can result in various payments and HMRC’s views on the VAT treatment of these has been unclear. Crowe’s Adam Cutler welcomes HMRC’s recent confirmations in this complex area.
Even with the introduction of the temporary VAT rate for the hospitality sector, the food and accommodation business has been one of the hardest hit by the pandemic. While the remaining COVID-19 restrictions are finally easing across the UK, it is clear that the impact of the last two years is leading many businesses to reconsider their operating locations. Where these are now no longer viable, operators may be looking to terminate their leases early and this brings some potential complexity in relation to VAT.
In September 2020, HMRC revised its policy in respect of the VAT treatment of early termination payments. Following representations, these changes were withdrawn and reconsidered, leading to a period of unwelcome uncertainty. In February 2022, HMRC confirmed its new approach, which must be applied from April 2022.
For most tenants, early termination of a lease will involve making a ‘surrender’ payment to the landlord, or if the landlord wishes to terminate the lease early they may pay the tenant a ‘reverse surrender’. As payments for supplies of interest in land, these are exempt from VAT unless the party being paid has opted to tax the property.
HMRC now views nearly all payments for early termination as further consideration for services for VAT purposes, even if the payment is described as damages or compensation. So, if you are also terminating equipment leases at the same time, VAT will be due on these charges.
HMRC now accepts that dilapidations (a payment the tenant agrees to pay if the property is not returned in the same condition as it was provided to them at the end of a property lease) will normally be outside the scope of VAT as it is in effect a damages or compensation charge.
Alternatively, a lease may be assigned to another party or the property sub-let. These have different VAT treatments, so it is important to consider the implications of both.
1. Assignment:
a. A payment to a new tenant to take on the lease is not considered a supply of land and will be standard rated.
b. A payment from the new tenant to the existing tenant is a supply of land by the existing tenant and will be exempt from VAT unless an option to tax is in place.
2. Subletting: the rent will be exempt for VAT unless an option to tax is in place. If opted, the rent will be subject to VAT at the standard rate.
The payment to the landlord to assign or sub-let is a supply of land by the landlord, so will be subject to the standard rate of VAT if the landlord has opted to tax the building.
Operators receiving a payment to surrender, assign or sub-let their lease will find themselves providing VAT-exempt services if they do not opt to tax the property. While this may be welcome by the other party, it may restrict the operator’s VAT recovery.
While there may be an understandable desire for landlords and operators to terminate leases quickly, in our experience VAT is not often considered; or, if it is, it is only done so when it is too late. These transactions are often high value and typically businesses are not familiar with the complex VAT property rules, so taking advice early can avoid expensive and unexpected issues arising later on.
