Commercial landlords and agents are now likely to have to pay VAT on compensation payments including dilapidations.

As the Government begins to claw back more money as the Covid-19 bill rises, its new advice makes clear that these payments are generally liable for VAT. 

Law firm Irwin Mitchell says the guidance has come in under the radar and is a departure from the normal position where a VAT change only applies going forward.

Tax partner Sarah Cardew (pictured, below) also tells LandlordZONE that the guidance is still under discussion as it’s been met with a lot of opposition.

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She explains: “Controversially, HMRC advises that any vatable person who has failed to account to HMRC for VAT on such fees must now correct their error as soon as possible.”

But it’s unlikely to include the payment of rents due when a tenant in a residential, rather than commercial, property quits a property early as residential property can’t be included within the HMRC ‘option to tax’ rule.

Generally land and property is exempt from VAT. An option to tax allows a business to choose to charge VAT on the sale or rental of commercial property and make a taxable supply out of what otherwise would be an exempt supply.  Any option to tax does not affect a residential building or residential part of a building.

Cardew says that while HMRC accepts that certain payments could still be considered true compensation and therefore outside the scope of VAT, such payments are often called compensation when they are really payment for a supply. 

In the past, true dilapidations payments were considered to be compensation which fell outside the scope of VAT.

Previous HMRC guidance was that break payments didn’t attract VAT either however, it seems that they do now.

If someone has paid a dilapidations payment inclusive of VAT, depending on the wording of the clause, they could try reclaiming 20% from the recipient says Cardew, who advises landlords to check transactions over at least the last four years. 

Other payments the guidance covers include those: by tenants following an exercise of break rights, provided that the landlord has opted the property to tax; by developers wanting to back out of an obligation to take a lease if a landlord has opted to tax; by landlords exercising contractual break rights (these should be exempt if a tenant has opted to tax); and interest for late payment of rent – subject to a landlord’s option to tax.

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