VAT and Stamp Duty Land Tax when existing leases between landlords and tenants are varied

Last week HMRC published guidance on how some arrangements between landlords and tenants affect VAT and Stamp Duty Land Tax (SDLT).

Whilst there have been no changes to either VAT or SDLT policy, variations to existing leases have become more frequent as a result of the COVID-19 pandemic.

Why has the guidance been published now?

As a result of the current COVID-19 pandemic, many tenants are suffering a loss of income and seeking to vary the terms of their lease with their landlord. The HMRC guidance outlines the appropriate VAT and SDLT treatment of the most common lease variations, specifically those which vary the amount of rent a tenant pays or where a lease extension is being agreed.

In all cases, the correct VAT and SDLT treatment will depend on the actual agreements which the landlord and tenant enter into.

VAT

A landlord and tenant are free to vary a lease between them in any way they choose. This may benefit the tenant as a period of reduced rent or a rent holiday for example.

If the tenant makes no payment or a token (peppercorn) fee there is no supply, and so no change in the tax liability of the supply made by the landlord to the tenant.

However, if the tenant agrees to do something in exchange, this could be classed as a payment for a supply by the tenant to the landlord.

If the tenant agrees to do something more, it is likely that the tenant is making a supply and the rent reduction will be the value of the supply. Whether the supply is taxable or exempt will depend on what the tenant agrees to do, in the same way as if they were being paid to do it. The landlord must account for the VAT as though the rent was still being paid if they have opted to tax the property.

If both supplies are taxable at the standard rate then the amounts of VAT due on each supply are likely to be the same. The landlord will be required to issue a VAT invoice to its tenant for the value of its supply. In turn, the tenant should issue a VAT invoice (at the appropriate VAT rate) to its landlord for the value of its supply. This is assuming that both parties are VAT registered.

Examples of possible variations

Landlord reduces the rental amounts payable but there are no other changes to the lease

Where the landlord has opted to tax, they will use the revised amount to account for VAT on the rent that is due. This is because the tenant is agreeing to continue to pay rent under the revised lease and is not making any supply to the landlord in return for the reduced rent.

Tenant agrees to an extended lease or variation to a break clause in the existing lease

The tenant does not make a supply to the landlord just by agreeing to pay rent under an extended lease. Where the landlord has opted to tax, they will need to account for VAT on the rent that is due in line with the revised timing and values.

Landlord changes the terms and, in exchange, the tenant agrees to more than paying rent during the lease

In this situation the landlord and tenant are making supplies to each other for VAT purposes. For example, the tenant may agree to do some work to the building for the landlord’s benefit. The tenant’s supply would be a taxable supply of construction services, and the landlord’s supply will be a supply of land that is exempt, unless the landlord has opted to tax.

New leases

If the tenant agrees to a new lease with new terms, they are not making a supply to the landlord just by agreeing. The liability of the landlord’s supply of the new lease will be exempt, unless the landlord has chosen to tax their interest in the property and the option is not excluded or disapplied.

If you discover that you have accounted for VAT incorrectly, you should follow the error correction process. Information about how to do this can be found at https://www.gov.uk/guidance/how-to-correct-vat-errors-and-make-adjustments-or-claims-vat-notice-70045

SDLT

Changes to a lease may also affect SDLT. This might include variations to existing leases or the grant of new leases for example.

If the tenant gives nothing in return for agreeing to the variations, there will not be any SDLT liability.

However, some arrangements can result in an SDLT liability and a requirement to file a land transaction return with HMRC.

These arrangements may include:

• extending the term of a lease – relief may be available for any rent on which SDLT has already been paid, often referred to as ‘overlap relief’
• the grant of a new lease which begins after the end of the current lease term, often referred to as a reversionary lease – any SDLT filing and payment liability will be from the date that the lease is signed or granted and not the date on which the lease term begins
• agreement by a tenant to carry out work on behalf of a landlord, for example in return for the landlord agreeing to reduce the rent payable
• the payment of any lump sum by either a tenant or a landlord in return for changes being made to a lease, or in return for the surrender of a lease

This list is not exhaustive. Both sides should take professional advice about their SDLT liability. Contact us for advice if you would like any more information, email enquiries@cowgills.co.uk.