The vast number of lease renegotiations in recent months have tended to involve either a rent reduction or rent free period in exchange for either the removal of a tenant’s break right or some form of extension to the term of the lease.

On 29 July HMRC published Revenue and Customs Brief 11 (2020) (RCB11) setting out the VAT and SDLT consequences of these types of deals. The brief notes that it has been issued in response to the current rise in lease renegotiations and that it does not reflect any change in HMRC’s policy or interpretation of the law, although many considered HMRC’s previous VAT position to be unclear.

VAT

Prior to RCB11, some tax advisers had expressed concerns that common lease renegotiation scenarios (particularly rent reductions/holidays in exchange for the removal of a tenant break right or an extended lease term) could have been treated by HMRC as a ‘barter’ transaction for VAT purposes. If so, both the landlord and the tenant would have been treated as making supplies to each other, meaning that both parties may have needed to invoice, charge and account for VAT. Such an outcome can create numerous complexities, including attributing an appropriate value to the supplies and dealing with situations where one party can recover VAT and the other cannot.

RCB11 is helpful in clarifying the following key points:

• If the tenant pays no more than a peppercorn fee (and does not provide any other form of consideration to the landlord – see below) in order to obtain the benefit of a reduced rent, rent-free period or rent holiday, then there are no changes to the supplies the landlord is making to the tenant under the lease: the landlord makes no ‘new’ supply in agreeing to the lease amendment and, assuming the landlord has opted to tax the property, the landlord should simply account for the VAT on the rent it charges to the tenant in line with the revised rent payment schedule (i.e. VAT should be charged on the reduced rent, rather than the rent that would have fallen due prior to the renegotiation).
• Where a tenant agrees to the removal of a break right or agrees to extend the term of a lease, the tenant should not be regarded as making a supply to the landlord. By implication, the tenant’s agreement to these changes should not be regarded as consideration for the landlord’s rent reduction. The tenant does not need to issue a VAT invoice in this situation and the landlord, if they have opted to tax, will simply issue VAT invoices in respect of the actual (revised) rent payable by the tenant.
• Where a tenant does ‘something more’ than agree to the removal of a break right or extend a lease term (RCB11 includes an example of a tenant agreeing to undertake works on the landlord’s behalf) the tenant could be making a supply to the landlord. If so, the amount of the rent reduction will be treated as the consideration for the tenant’s supply. This could result in a requirement for the tenant to issue a VAT invoice to the landlord for an amount equal to the rent reduction and a corresponding requirement on the landlord to account for VAT on the original (higher) rent.

The rationale behind HMRC’s position aligns with their longstanding view in relation to payments made by landlords to induce tenants to enter into a new lease. In most situations, an inducement payment to a tenant is not subject to VAT on the basis that the tenant does not make a taxable supply to the landlord when all they are doing is agreeing to pay rent under a lease. RCB11 extends this logic to lease renegotiation scenarios: by agreeing to remove a break right or extend a lease term, all the tenant is doing is ‘agreeing to pay rent’ for a longer (or more definite) period, so the benefit of a reduced rent does not constitute consideration for any supply by the tenant. However, as with landlord inducement payments, where the tenant is doing more than ‘agreeing to pay rent’, HMRC are likely to treat the tenant’s actions as a taxable supply. A common scenario would be a commitment by the tenant to carry out works on the landlord’s behalf (as per HMRC’s example in RCB11). However, this could cover a multitude of other possible tenant supplies, potentially including a ‘pre-wired’ tenant consent for the landlord’s benefit or other variations to the lease which do not relate to rent payment terms, the duration of the lease or break rights.

SDLT

RCB11 also includes a helpful reminder of the SDLT position for lease variations. Broadly, a reduction in rent will not normally create an SDLT liability. However, further consideration should be given to situations involving extension of lease terms, grants of reversionary leases or agreements for the tenant to do more than just pay rent (eg. carrying out landlord’s works) as such arrangements may give rise to an SDLT liability and a requirement to file a return with HMRC.

Comments

The tax consequences of lease variations are rarely straight forward – each arrangement should be considered on its own facts. The VAT guidance will be a welcome clarification for landlords, tenants and advisors, alleviating concerns about notoriously complex barter transactions in many common scenarios. However, many were hoping that HMRC’s guidance would be more comprehensive – further guidance covering situations where tenants are providing ‘something extra’ would have been helpful.

Landlords and tenants who have previously applied barter transaction VAT treatment to lease renegotiations should consider whether VAT was incorrectly accounted for in light of RCB11, and whether an error correction may be necessary.

If you would like to discuss the VAT or SDLT position of any of your lease arrangements, then please reach out to your usual Bristows contact or a member of our tax team.