Rent variations and lease extensions: VAT and SDLT consequences

HMRC has released guidance to assist business deal with the VAT and SDLT consequences of extending or varying leases. Revenue & Customs Brief 11 (2020) sets out HMRC's understanding of the VAT and SDLT treatment of a number of scenarios involving rent variations and lease extensions. The new guidance will be welcomed by taxpayers and advisers as such arrangements have become increasingly common as a result of the COVID-19 pandemic.

Background

Many businesses have found themselves in short-term financial difficulties due to the COVID-19 pandemic.  With occupancy costs a significant expense for businesses, many business tenants have sought to renegotiate  the terms of their leases to reduce costs/improve cash flow.

Often, the basis for this negotiation is a change to the terms under which rent is payable (for example, a short-term rent reduction such as  a rent-free period), in return for the tenant committing to lease the property for a longer period than they otherwise would.  These arrangements might involve, for example, a waiver of a tenant's break right in the lease and/or an effective extension of the term of the lease through varying the lease term (a deemed surrender and regrant under land law), a surrender and regrant or the grant of a reversionary lease.

These arrangements give rise to some uncertainty from a tax perspective, especially with regard to their VAT treatment. In particular, it has been unclear in what circumstances HMRC would see a barter arrangement arising for VAT purposes in circumstances where a tenant agrees to a change in the terms of a lease in return for a rent reduction. A barter arrangement would result in both landlord and tenant being treated as making supplies to each other, with the potential need to charge and account for VAT on the value of the supplies.

The uncertainty in the treatment of these arrangements is something that well-advised landlords and tenants have been grappling with for some time.  However, the increased incidence of lease renegotiations due to COVID-19 has resulted in increased numbers of taxpayers seeking rulings from HMRC, accelerating HMRC's engagement with this issue at a policy level.

Guidance: VAT

HMRC has now published helpful guidance on the VAT consequences of the most common lease variations currently being negotiated between landlords and tenants, specifically those that vary the amount of rent to be paid by a tenant and where lease extensions are being agreed. Although given in the context of COVID-19, the guidance is not specific to the current situation and is simply a statement of HMRC's understanding of such arrangements.  The guidance appears to take a less legalistic approach to these arrangements than may have been the experience of taxpayers/advisers which have previously approached HMRC for a view on the VAT treatment of particular transactions.  As a result, this guidance is likely to result in fewer barter arrangements having to be recognised than might otherwise have been expected.

Where a landlord and tenant vary the terms of a lease between them to reduce the rent payable, whether by means of a reduced periodic rental payment or a rent-free period, then provided this is done by the tenant for no consideration (or a token fee such as a peppercorn) then there will be no supply for VAT purposes. 

By contrast, if the tenant agrees to do something in exchange for the rent reduction, then the rent reduction could be a payment for a supply by the tenant to the landlord for VAT purposes. There had been considerable doubt as to whether the tenant's agreement to merely continue being a tenant (perhaps by agreeing not to exercise a break right or agreeing to an extension of the term of the lease) could amount to consideration in these circumstances.

HMRC's guidance accepts, however, that the tenant is not doing something in consideration of the rent reduction by merely agreeing to accept the normal obligations of a tenant, such as paying rent. Examples included in the Brief make it clear that this includes where the tenant: (a) agrees to an extended lease or variation to a break clause in the existing lease; or (b) agrees to a new lease with the landlord which has new terms (which would appear capable of covering both a situation where there is surrender and regrant or the grant of a reversionary lease).  The Brief confirms that a tenant does not make a supply to the landlord merely by committing to pay rent under an extended lease or by agreeing a new lease.

Nevertheless, where the tenant agrees to do anything else in return for the rent reduction, then this may amount to a supply. For example, where the tenant agrees to undertake works to the building for the landlord's benefit in return for the rent reduction, then that would result in both a supply by the tenant to the landlord (a taxable supply of construction services by the tenant) and by the landlord to the tenant (a supply of land by the landlord, such that the landlord must account for VAT as though the rent was still being paid where an option to tax has been made).

HMRC's guidance is not limited to straightforward rent reductions through a reduced rent or rent-free period.  It is apparent from the Brief that renegotiations under which other changes to the terms on which rent is payable which are potentially of value to a tenant should be treated in the same way.  These include deferrals of rental payments, as well as changes to the frequency of rental payments, to the basis for calculating rent (such as switching to a turnover rent) or to rent review provisions.

Guidance: Stamp Duty Land Tax: SDLT

Arrangements in relation to lease such as variations to existing leases, or the grant of new leases may have SDLT consequences. 

The guidance confirms that some changes, such as reductions in rent, may not give rise to any SDLT liabilities if nothing is given by a tenant in return for agreeing to such changes.  However, the guidance gives the following examples of arrangements which may result in an SDLT liability, and a requirement to file a land transaction return with HMRC:

• Extending the term of a lease (relief may be available in respect of any rent on which SDLT has already been paid by way of "overlap relief");
• The grant of a new lease which begins after the end of the current lease term (a reversionary lease) with any SDLT filing and payment obligations arising by reference to the date that the lease is signed/granted, rather than the date on which the lease term begins;
• Agreement by a tenant to carry out works on behalf of a landlord (for example, in return for the landlord agreeing to reduce the rent payable under a lease);
• The payment of any lump sum by either a tenant or a landlord in return for changes being made to a lease, or in return for the surrender of a lease.

Comment

The uncertainty in the tax treatment of lease variations has added undue complexity to common lease renegotiations for which time is of the essence in the current COVID-19 environment.  A barter analysis can also raise the prospect of VAT costs for tenants which would erode some of the benefits of the changes to lease terms being negotiated.

This guidance from HMRC on the VAT treatment of lease variations will, therefore, be greatly welcomed by landlords, tenants and their advisers, in clarifying that a barter arrangement does not need to be recognised for VAT purposes in many cases.

Landlords and tenants which have accounted for VAT on lease variations on the basis of a barter treatment applying will need to review these historic transactions in light of HMRC's guidance to determine whether VAT has been accounted for incorrectly and whether any error correction notifications should be made.  Where both supplies were taxable and equal amounts of VAT accounted for by the landlord and tenant on their respective supplies, there should have been no loss of revenue to HMRC.  However, that will not be the case where one "leg" of the barter was VAT exempt.