In the second of this two part blog we look at the VAT consequences of lease variations.

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, but often the parties do not appreciate that there has in fact been a supply.

For example, it is not uncommon for the parties to vary a lease to remove a tenant’s break option in consideration of an additional rent free period. If the landlord has opted to tax the property, it should charge VAT on the value of the consideration (from the landlord’s perspective) given by the tenant (i.e. the value of the tenant’s break option). If the variation is an even commercial deal, then the value of the tenant’s variations will be the same as the value of the landlord’s variations. So in this example the value of the tenant’s break option will be the same as the rent the landlord is forgoing.

If the tenant has opted to tax the property it would also have to charge VAT on the variation. In that case, the parties can agree to 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. This will clearly have a cash flow advantage and for this reason a tenant may want to opt to tax its interest in the property ahead of the variation.

The position is more complex where a variation causes a deemed surrender and re-grant. As discussed in the first part of this blog, this may be an unintentional consequence of a lease variation (for example if there is an increase in the duration of the lease or in the extent of the demise). HMRC issued a statement of practice on this topic in the 1990s suggesting that the deemed surrender and re-grant will sometimes be accepted as a non-event for VAT purposes, probably reflecting the fact that they often represent the functioning of land law rather than transfers of commercial value.

However, the treatment of the deemed surrender and re-grant needs to be considered in the context of the transaction as a whole: VAT may well be chargeable on other elements of the transaction. The statement of practice does envisage that VAT will be charged on the surrender if a landlord pays cash, or if the demise or term is reduced (subject to an option to tax). Likewise, if the tenant pays cash for the variation VAT is usually charged on the deemed re-grant, or alternatively the landlord may be seen as making a taxable supply of accepting the surrender of the old lease if, for example, it is onerous. Advice should be taken on a case by case basis.