Surrendering a lease - does VAT apply?
One of our subscribers has agreed to waive the arrears of rent owed by her tenant. In return the tenant will give up the lease on the property so that a new lease can be granted to a new tenant. Our subscriber wants to know if there’s VAT to pay?
Land and property transactions
A supply of land or buildings, e.g. the granting of a lease, is usually an exempt supply for VAT unless it relates to a new building or the landlord has opted to tax the property. The rules for transactions involving land and buildings are tricky to say the least. So, the first step in answering our subscriber’s question is to decide the exact nature of transactions involved in the arrangement, that is who is paying what to whom, and what are they getting in return? This is always a good starting point when deciding the VAT position.
Is there a supply?
Usually, for VAT to apply to any type of transaction two elements must exist; one party must supply goods or services and the recipient must give consideration (payment in some form) for them.
Trap. While there are exceptions to the general rule which are designed to prevent tax avoidance, usually a one-sided transaction, i.e. either a payment made for nothing, or the supply of goods or services for no payment, isn’t subject to VAT.
Who is making the supply?
In this case our subscriber isn’t supplying anything to her tenant but she is giving monetary consideration to them in the form of waiving the rent she is owed. By itself this isn’t VATable because it’s payment without a supply and if that were all that was involved in this case she could forget the VAT. But there’s more. In return for the rent being waived the tenant is handing back the lease (surrendering it) to our subscriber. So, there is both a supply (services) made by the tenant and consideration given by our subscriber.
Is it an exempt or VATable supply?
We know that there is a supply within the scope of VAT (some types of supply are completely outside the scope of VAT, e.g. employment in return for wages, transfers of businesses) and that it relates to land or buildings, we need to decide if it’s exempt or subject to VAT at the standard or other rate. For that we need to know:
is the property new?
is it commercial or domestic (residential)?
The answers in respect of our subscriber’s property are “no” and “commercial”. That would make the transaction a VATable supply. But that’s not the end of the story. Following an historic ruling by the European Court of Justice in 1994, HMRC made changes to the VAT rules for transactions involving inducement payments connected to the surrender of leases. The broad effect of these is to make all such transactions and those with similar characteristics VAT exempt unless the tenant had opted to tax the property, which they hadn’t.
Other tax issues. Neither our subscriber nor her tenant have to worry about VAT applying to the surrender of the lease. The bad news is there are tricky income/corporation tax consequences which also need to be considered. We’ll therefore look at these in a separate article.
For VAT to apply there must usually be a supply of goods or services and consideration (payment) for them. Both factors exist in this surrender of a lease and so it would appear VATable. However, special rules were introduced that specifically make the surrender of a lease VAT exempt unless the tenant has opted to tax the property.