VAT Treatment Of Early Termination Fees

HMRC published a Business Brief on 2 September 2020 which changed the vat treatment of payments made for the early termination of leases i.e. lease surrender payments. It also had an impact on other fees paid to get out of a contract early.

The Business Brief resulted in vat being payable on the early termination fees where the underlying contractual payments had also been subject to vat. The bad bit about the Business Brief was the suggestion that the “new” vat application was retrospective so HMRC would look back 4 years.

HMRC have now announced that they are reviewing and revising the Business Brief because they may have applied the vat cases that caused the change in approach too widely (the cases involved vat on payments to end mobile phone contracts). This could be as a result of a massive lobbying effort by the property industry and advisers, particularly regarding the retrospective element of the Business Brief.

Businesses now have a choice according to HMRC and they can:

  • continue to treat payments that fall within the Brief as further consideration for the contracted supply i.e. charge vat on early termination payments, or
  • go back to treating them as outside the scope of VAT, if that is how they treated them before the Brief was issued i.e. not charge vat.

What Should Clients Do?

There is a risk that HMRC will continue to treat the termination payments as subject to vat – there is some logic to their approach as the underlying supply (rent in the case of leases) is subject to vat. A similar rule already applied to some damages payments for breach of contract. Therefore, I would recommend that vat continues to be charged on termination payments. It is much easier to collect the vat at the time of termination than have to go back to the tenant after the event – the “cash is king” approach. If HMRC go back to the second bullet point, a refund of vat can be provided with vat credit notes being issued.

The vat position of dilapidation payments paid by a tenant at the end of a lease does not change – “dilaps” are treated as a payment of damages and are outside the scope of vat i.e. no vat is payable on a dilapidation payment.

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