Background
The publication of HMRC’s Revenue and Customs Brief 12/20, on 2 September 2020 (“RCB 12/20”), indicated that HMRC’s default position as to the VAT liability of dilapidations payment may have changed. Referencing case law from the Court of Justice of the European Union; the Brief suggested that a payment from a customer to a supplier (even a compensatory one) is further consideration for the original supply and so liable for VAT if the original supply was.
Whilst RCB 12/20 did not expressly deal with dilapidations payments, the principles outlined within it suggest that dilapidations payments can be chargeable to VAT if the underlying agreement is also chargeable to VAT (such as a lease subject to an option to tax).
Essentially, HMRC’s position is that dilapidations payments arise directly from the agreement between the landlord and tenant and, as the landlord and tenant agree at the outset that the property is to be returned in the same state as it was let, a dilapidations payment is effectively a cost to the landlord of making the supply, and so is further consideration for that supply.
In RCB 12/20, HMRC also said that they would apply the new approach retrospectively for the last four years.
The Historic Position
At the time of writing, paragraph 10.12 of HMRC’s VAT Notice 742 states the following:
“A dilapidation payment represents a claim for damages by the landlord against the tenant’s ‘want of repair’. The payment involved is not the consideration for a supply for VAT purposes and is outside the scope of VAT.”
Historically this position, namely that dilapidations payments are outside the scope of VAT, was widely understood to be the view of HMRC. Accordingly, landlords and tenants have for many years operated on the assumption that HMRC will not seek to assess VAT on dilapidations settlements.
Industry Concerns and HMRC’s Abandonment of Retrospective Effect
Following the publication of RCB 12/20, the real estate industry raised concerns about the impact on HMRC’s treatment of dilapidations payments for VAT purposes. In particular, landlords were concerned with how to approach the potential liability for dilapidations settlements long since agreed.
HMRC has since said that it is going to reconsider the position and has confirmed that it will not be pursuing retrospective effect for any policy changes set out in RCB 12/20. The abandonment of the position in respect of retrospective effect will be of particular comfort to landlords who have agreed dilapidations settlements during the previous 4 years on which VAT was not charged.
HMRC were expected to announce their views on the VAT treatment of dilapidations payments on 1 February 2021, but this date was pushed back until 1 March 2021. However, at the time of writing HMRC are still considering their position.
British Property Federation (“BPF”) Representations
One reason as to why HMRC are still considering their position as to the VAT treatment of dilapidations payments is that they are continuing to consider representations made to them by industry bodies.
The BPF (with input from Wedlake Bell) has made representations to HMRC setting out why dilapidations payments should not be chargeable to VAT. This is primarily because the basis on which a dilapidations payment is made is not ordinarily set out in the underlying contract (i.e. the lease); such payments cannot therefore be consideration for a supply under the lease for the purposes of the cases cited by HMRC in RCB 12/20. It follows that dilapidations payments should continue to be treated as being outside the scope of VAT.
Conclusion and Takeaways
It remains to be seen what HMRC’s ultimate conclusion will be as regards the VAT treatment of dilapidations payments, but an announcement is anticipated over the next month or so. For the time being, given that HMRC have confirmed that any policy change will only be applied prospectively (rather than retrospectively), landlords should ensure that dilapidations settlements are stated to be plus VAT (if chargeable). Doing so will allow them to charge VAT to their tenant in the event that HMRC ultimately take the position that VAT is chargeable on dilapidations payments.