In the current economic climate, we are seeing more and more lease restructures - particularly break options being removed coupled with the grant of rent-free periods. Landlords and tenants keen to mitigate the effects of the Covid – 19 lockdown who are discussing lease variations need to make sure that they are aware of any VAT implications.
If either party has opted to tax the property for VAT purposes then VAT will need to be charged on any supplies treated as made by that party even if the supply is not money but the value of a non-cash consideration.
In lease regears involving break removals in exchange for the grant of rent frees that we have seen in the current market, the general consensus is that the non-cash value of the break removal/regear is equal to the non-cash value of the rent-free period being given (ie it is an equally balanced arm's length commercial deal). However, even where the value of the tenant’s break option is the same as the rent the landlord is forgoing, if the property is VAT elected this could be a mutual supply which carries with it VAT implications. Specifically, both parties need to ensure that a separate valid VAT invoice is produced for the value of the consideration in each VATable supply.
In this mutual supply for equal value situation the VAT is bartered - ie the parties swap VAT invoices on completion marked “paid” rather than paying an equal amount of cash to each other. The net effect on their VAT accounts should be neutral assuming both can recover the input VAT in full.
VAT barters don't just arise in lease regears, they also crop up in certain types of lease incentives (for example if a reduction in rent or a rent free granted by a landlord in return for the tenant carrying out some work to the property). Generally, the grant of a rent-free period (such as a normal rent-free period granted at the beginning of a lease for fit out) doesn't count as consideration for a supply by the tenant. However, a rent free period can constitute consideration where the tenant is providing a benefit to the landlord such as carrying out improvements to the building.
Consequences of missing a VAT barter
Missing a VAT barter could give rise not only to a liability to HMRC for penalties and interest but also to fund the VAT itself if it can't be recovered from the other party. Specifically, from a landlord's perspective, they could suffer a loss due to them not receiving a valid VAT invoice from a tenant at completion.
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It is important that landlords and tenants take proper professional advice when granting or restructuring leases in order to avoid any unintended VAT pitfalls. Appropriate wording in the contract needs to cover off the value of each party's supply, to make it clear that the value is exclusive of VAT and to provide for the issue of VAT invoices by each party that is making a taxable supply and for payment where the VAT isn't being bartered. We are here to advise and support you in dealing with these issues.