VAT and break termination payments – recent ruling goes against tenants

The recent decision in Vengtrove Ltd v Kuene Nagel Ltd [2022] means tenants should be extra diligent when exercising any break clauses in their leases which involve termination payments and ensure that any VAT is paid thereon if there is an option to tax in place.
 
The latest decision in the case, which was heard in the Inner House of the Court of Session in Scotland, is an appeal from an earlier decision whereby the Judge had ruled that VAT was not due on break clause termination payments despite the wording in the lease and an option to tax. 

The latest decision reverses that. On appeal, the Court and has now concluded VAT was due on the break clause termination payment and the break clause here had not been validly exercised as a result. The tenant is now running an estoppel argument, essentially seeking to debar the landlord from insisting the break was not effective. There will be another hearing but, for now, essentially, VAT would not normally be due on a break clause termination payment in a break clause unless there is an option to tax in place and, if there is, VAT should be paid.
 
Tenants should be checking any break clause carefully and, if it includes a termination payment and the property has an option to tax, the tenant should seek specialist VAT advice on the current position. However, if that is not an option, the safest route would be to pay the VAT and argue about it later.

The payment could be taken towards dilapidations by the landlord but, of course, there is a risk of never getting that money back if the landlord enters into any insolvency regime. However, by paying it over it will limit any argument that the break clause has not been validly exercised due to non-payment of VAT and the lease continuing (subject to compliance with any other break conditions). 
 
Landlords should also be carefully checking a tenant’s strict compliance with any break clause too. Be careful not to inadvertently waive compliance with any break conditions if they are keen for the tenant to remain in the premises, for example, if they would find it difficult to re-let the property.

If you need help in understanding the potential pitfalls in your break clause, please contact a member of the team on 03333 231 580 or email enquiries@dmhstallard.com