HMRC guidance around VAT and dilapidation payments

Readers may recall the slight degree of panic within the property industry in September 2020 when HM Revenue & Customs (“HMRC”) issued guidance on VAT and termination payments, which you can see more details of here.

This guidance suggested that dilapidation payments on termination of a lease could be subject to VAT and that HMRC would look back for a 4-year period where VAT had not been charged. HMRC suspended the guidance in January 2021 as a result of feedback from the property industry.

On the 7th February 2022, HMRC issued revised guidance (in Revenue and Customs Brief 2 (2022)) on VAT and termination payments and published revised pages from their VAT Manual which will take effect from the 1st April 2022.

The good news for property professionals is that HMRC will not look to charge VAT on dilapidation payments on the basis that the payments exist to ensure landlords are not out of pocket if buildings are not returned in the agreed condition at the end of the lease. Dilapidation payments will be “outside the scope” of VAT and the historical treatment of the payments will continue.

HMRC takes the view that there is not a sufficiently strong link between the rent paid under the lease for use of the property and the dilapidation payments. If the tenant satisfies their obligation to “repair” under the lease, no dilapidation payments will arise.

HMRC reserves the right to depart from this view if they come across landlords and tenants changing their rental payments to avoid vat by shifting the value from the rent to the dilapidation payments. From a professional advisors’ point of view, this would be seen as tax avoidance and a dim view may be taken by professional regulators in participating in tax avoidance.

Please contact Andrew Evans below or your normal contact at Geldards if you have any questions about this briefing.