A recent Scottish case (Ventgrove Ltd v Kuehne and Nagel Limited (2021)) has provided some useful clarification on whether VAT is due on a payment due under a commercial lease in order to ensure the break was effective.
In this particular case, in order for the tenant to terminate the lease, they needed to pay £112,500 “together with any VAT properly due thereon”. The landlord had opted to tax the building and argued that, as the tenant had not paid the VAT on the termination payment, the break was not effective.
Previously, where a break option was contained in the original lease, such payments have always been treated as outside of the scope of VAT following the decision in Lloyds Bank plc v Commissioners of Customs and Excise LON 95/2424 in 1996; but the position since late 2020 has not been entirely clear-cut.
Following two decisions in the ECJ in relation to compensation payable by a customer for termination of fixed-period telecommunications contracts prior to the end of the fixed period*, HMRC changed its guidance in September 2020* to treat payments arising out of early contract termination as consideration for a taxable supply where the original contract allows for such a termination, as well as when a separate agreement is reached.
However, in January 2021* HMRC altered its position and updated its Business Brief to make it clear that the change in policy was not to be given effect until a later date and indicated that it would issue revised guidance, and a new Revenue and Customs brief, to explain what businesses need to do shortly. Until then, parties could “go back to treating them as outside the scope of VAT, if that is how they treated them before this brief was issued”. The same guidance applied to dilapidations payments.
12 months on, such guidance has still not been issued by HMRC and, therefore, at the time when the break notice was served (23 February 2021), the Court held that HMRC’s policy as set out in the Lloyds case still applied and the payment was not taxable. There had been no cases in which a court or Tribunal had considered whether the exercise of an option to terminate within an original lease is a taxable transaction or any UK Court or Tribunal decisions on the matter. The Court held that the meaning of “together with any VAT properly due” meant any VAT properly due to HMRC and, here, none was due, so it did not need to be paid. The Court also held that if HMRC changed its guidance, the indemnity under the lease would allow the landlord to recover the applicable VAT from the tenant.
The interesting points here, though, are the comments made by the Court that they considered the two cases in the ECJ which led to HMRC changing its guidance in the first place in 2020 were “not directly in point” to. Both of those cases related to compensation for failure to complete the minimum contractual term, calculated as the whole of the remaining monthly charges (MEO), or the costs incurred by the supplier (Vodafone), which is not the same situation as a contractual entitlement to bring a contract to an end after a specified period upon payment of a fee.
In MEO the Court held that the predetermined amount received by an economic operator where a contract for the supply of services with a minimum commitment period is terminated early by its customer, which corresponds to the amount that the operator would have received during that period in the absence of such termination, must be regarded as the remuneration for a supply of services for consideration and subject to VAT (para 57). In Vodafone, the Court held that amounts received by an economic operator in the event of early termination of a services contract requiring compliance with a tie-in period in exchange for granting that customer advantageous commercial conditions must be considered to constitute the remuneration for a supply of services for consideration (para 50).
In this case however, neither of those scenarios applied. The lease was not terminated prior to the expiry of a minimum period, but at the end of a minimum period. The £112,500 did not correspond to the amount of rent that the landlord would have received had the lease run for its full term of ten years at a rent of £450,000 per annum. The tenant did not fail to comply with a tie-in period either. In February 202, the initial tie-in period had expired and the tenant had a contractual right to bring the lease to an end by exercising the break option.
As a result, its now questionable whether HMRC will alter its position at all as to whether such payments are now taxable, given that these earlier cases are not relevant here.
Whilst we all hope HMRC will issue its guidance sooner rather than later, for now, landlords should include similar wording in their leases to cover any VAT which may be due on a termination payment and tenants should be aware that the position on VAT is not clear-cut but should factor in that VAT could be payable on a termination payments and dilapidations until further definitive guidance is issued by HMRC.
*MEO Servios de Comunicaões e Multimédia SA v Autoridade Tributária e Aduaneira (Case C-295/17) EU:C:2018:942 (issued on 22 November 2018) and Vodafone Portugal Comunicaões Pessoais SA v Autoridade Tributária e Aduaneira (C-43/19)  STC 1975
* Revenue Customs Brief 12 (2020) and set out in VATSC05910, VATSC05920 and VATSC05930
*update to Revenue Customs Brief 12 (2020)