Update: following the publication of this article, it is now understood that HMRC's proposed changes to its guidance will only apply from 1 March 2020 (or possibly later). We intend to publish another article when HMRC's full updated guidance is released, but wanted to ensure that readers of this article note this key change
In September, HMRC issued its Revenue and Customs Brief 12 (2020). This set out HMRC's new policy concerning VAT on compensation, liquidated damages and similar payments related to the termination of agreements. HMRC's change of approach followed judgements of the Court of Justice of the European Union (CJEU).
We commented on HMRC's new policy last year in our article: "New HMRC Policy on VAT and Termination Payments – Implications for the Real Estate Sector". In this article, we pointed out that HMRC's new guidance, which accompanied their change in policy, failed to resolve key areas of uncertainty for the Real Estate Sector.
While, at the time of writing, HMRC's published guidance remains the same as it was in September, we understand that HMRC has now refined its position.
We have explored some of the implications of HMRC's clarifications below. However, it is important to bear in mind that HMRC has not yet updated its published guidance to reflect what appears to be its current understanding, and HMRC is unlikely to do so until late January 2021.
From what we now understand, it appears that HMRC is moving away from applying the change in their guidance retrospectively (which could impact transactions in the last four years). Instead, we understand that HMRC has suggested that the changes in their guidance will only apply from 1 February 2021. It is not clear how this affects taxpayers who have already tried to apply HMRC's guidance.
If HMRC updates its guidance to reflect this position, it will alleviate concerns about the retrospective application of HMRC's change of policy. However, until HMRC make a clear pronouncement to the effect that its change in policy will only apply from 1 February 2021, it may be advisable to review past transactions and request a specific opinion from HMRC where a potential issue is uncovered.
HMRC's position is that early termination payments and similar payments will be consideration for a VATable supply (and so subject to VAT) if those payments are related to the costs of the supplier in making a VATable supply under the related contract, or if they are broadly equivalent to what such a supplier would have charged if the contract continued without termination.
HMRC has commented on the implications of this view in the context of dilapidation payments. HMRC states that its view is that dilapidation payments are consideration for a VATable supply, if the dilapidation payments relate to works that are required to make good as a result of a tenant using the property for a use permitted in the lease (or otherwise permitted by the landlord).
Dilapidation payments are then only outside the scope of VAT where they are required to make good damage caused by the the tenant using the property for a purpose not permitted in the lease (or otherwise permitted by the landlord). The implications of this are unclear and, on their face, could result in an apportionment between damages caused by normal use and damages caused by a use that was not permitted.
It is hoped that HMRC will provide more details on the implications of their new policy in their revised guidance when it is updated. However, for the time being, it may be wise for landlords charging dilapidation payments to tenants to seek HMRC's opinion on the specific payment in question, or at least attempt to agree the VAT position (and appropriate landlord protections) with the tenant – although this may be difficult in some dilapidation payment scenarios.
DWF's Tax Team has significant experience in advising on a wide variety of Real Estate sector matters, including large developments and forward funding arrangements, real estate financing, investment property acquisitions and restructuring and complex lease arrangements. Please contact James Cashman or your usual DWF contact if you would like to discuss the implications of HMRC's change of policy on VAT and termination payments.
Authors: Jon Stevens, James Cashman, John Toon, Caroline Colliston and Alex Tolcher.