The current Covid-19 related environment has impacted on lease arrangements, with a rise in variations to existing lease terms. Such variations take many forms but often include a rent free or reduced rent period. This might be agreed in return for removing a break right, extending a lease term or the tenant providing something else in return. This trend has focused minds on the tax treatment of such variations and whether a variation amounts to a "barter transaction" for VAT. A barter arises where non-cash consideration passes and results in the landlord making a supply to the tenant and the tenant a supply to the landlord in return.
HMRC has now issued guidance on the VAT and SDLT treatment of lease variations. The guidance summarises how the VAT and SDLT rules work in this area and gives some useful examples of how HMRC applies the law in practice.
The basic position, as confirmed by HMRC, is that if the landlord agrees to a variation and the tenant agrees to do something in exchange, this could be classed as a payment for a supply by the tenant to the landlord unless they are only agreeing to accept the normal responsibilities of a tenant, such as paying rent. This is familiar territory and the basis for most reverse premiums being treated as outside of the scope of VAT where the tenant is doing no more than agreeing to take the lease.
It is therefore important to understand when a tenant is treated as doing something in exchange. HMRC has provided some examples to illustrate how it applies the law.
- The landlord reduces the rent payable but there are no other changes to the lease. HMRC's view is that the tenant is agreeing to pay a revised rent and is not making a supply. The landlord will continue to charge VAT (assuming an option to tax has been made) on the reduced rent in the normal way.
- The tenant agrees to an extended lease or variation to a break clause in an existing lease. HMRC states that the tenant does not make a supply to the landlord just by agreeing to pay rent under an extended lease. Whilst the heading to the example in the guidance refers to variations of break rights, the actual example provided only discusses lease extensions. However, HMRC has since clarified that the removal of a break right given only in return for a rent free period is treated as equivalent to the creation of a lease extension and is also not treated as a supply by the tenant. This is because it has the effect of ensuring rent is paid for a longer period.
In the past, the waiver of a break-clause in return for a rent free period would have been treated by many advisers as a barter transaction. There remains scope for a barter transaction to arise with more complex arrangements where the variation to a break right gives rise to something more than an agreement to pay rent for a longer period. Each case should be considered on its facts.
- The landlord changes the lease terms and, in exchange, the tenant agrees to more than paying rent during the lease e.g. doing some work on the building for the landlord's benefit. HMRC makes it clear that these are both supplies. If we take the example of a rent reduction in return for works, the landlord would still have a supply of land (the rent forgone) and the tenant's supply would be of construction services. Both parties would have to issue VAT invoices if their supply is subject to VAT.
The guidance also addresses SDLT and provides a useful reminder of the SDLT position that:
- Where there is a variation to a lease and the tenant gives nothing in return there should be no SDLT liability.
- Where it is agreed that a new lease will be granted after the end of the current lease term then the SDLT is due on the date the lease is signed or granted and not the later term start date.
- A tenant's works for a landlord in return to reduced rent could lead to SDLT liability.
- Paying a lump sum in return for lease variations could lead to a SDLT liability.
Osborne Clarke comment
HMRC's guidance is useful in providing clarity for landlords, tenants and advisors and should remove the need in some cases to consider if there is a so called "barter" transaction.
Where the lease variations are complex and involve the tenant agreeing to do more than is noted in the examples above, due consideration will still be needed as to whether there are supplies each way for VAT and the value of such supplies. Often there will be matching supplies without the need for cash payment of the VAT to pass, albeit it is still important that the VAT invoicing and compliance is dealt with correctly.