An important change has been noted in our occupiers' quick guides (https://www.forsters.co.uk/occupiers/corporate-occupier-quick-guides#Dilapidations).
Dilapidation payments may attract VAT!
This is contrary to the statement in HMRC Notice 742: "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. "
The dilapidations point has come out of the Revenue & Customs Brief 12/20 and the accompanying amended revisions to the VAT Supply and Consideration Manual, where HMRC started positing the view that liquidated damages may often disguise a VATable supply. As HMRC said in that guidance the "question will be, why isn't other income it [the supplier] has received also within the scope of VAT, particularly if it is from the same customer?"
Concerns were raised by the British Property Federation (BPF) and others regarding the treatment of dilapidations, and in particular if there were a change in approach, would that be retrospective?
The good news was that HMRC confirmed that their change of approach only takes effect from 1 February 2021 and it is understood that HMRC may extend that date to 1 March 2021. The bad news is the potential change of opinion.
HMRC issued draft guidance (an informal consultation) at the beginning of January 2021. This draft guidance refers to the wear and tear that would be reasonably anticipated in the case of the hire of a car and that payment by the user for that damage is in effect further deferred consideration for the use of the car. Egregious damage, i.e. writing off the car, would not be something that the hire contract would envisage and so such a payment would normally be outside the scope of VAT.
HMRC consider that the same logic applies to dilapidations. We disagree, and joined with the BPF and others to point out that dilapidation payments are not effectively deferred rental payments, as HMRC consider them to be. Whilst this may be a pertinent view in respect of car hire, it is not correct for land.
Nevertheless, we consider that landlords and occupiers should take VAT into account when agreeing dilapidation payments in respect of VATable buildings. Whether the key date is 1 February 2021, 1 March 2021 or another date is yet to be seen. Clarification of both the treatment of dilapidation payments and the timing of any change is urgently needed, as real life negotiations are taking place.
"Another example of a fee which is further consideration for the supply is a dilapidation payment. These occur where a lease specifies that a tenant must return the building in the same state as they received it at the end of the lease or pay the landlord a fee to enable the work necessary to restore the building to its former state. Both parties have agreed the building will be returned in the state it was originally let. The costs off putting the building back in that state are costs of the tenant. If the contract did not provide for the tenant to bear these costs the landlord would probably charge a higher rent to enable him to restore the building to its former state at the end of the of the lease. If the tenant does not make good the building and instead pays the landlord a fee these are costs of the landlord which are directly linked to the supply of letting the building and are further consideration for that supply. " HMRC draft guidance January 2021