If your business rents its premises you’ll usually need express permission from the landlord to make alterations to the property. Even then there’s a hidden trap that might prevent you from recovering VAT on the costs. How can you avoid it?

Landlords and tenants

Repairs and improvements can be a source of tension between landlords and tenants. A typical lease will require tenants to maintain the property, plus they are usually allowed to make “reasonable” improvements subject to agreement from the landlord. It’s this last point that can cause VAT trouble.

Who’s benefiting

At the end of a lease the property, including any improvements made by the tenant, reverts to the freeholder. This raises the question of whether in making an improvement to the property, say an extension, it’s the freeholder rather than the leaseholder which is receiving the supply from the builder carrying out the improvement. If it’s the freeholder then the leaseholder isn’t entitled to reclaim VAT on the building costs.

Trap. It doesn’t matter that the leaseholder pays for the work, only the recipient of the supply can reclaim the VAT. If the freeholder isn’t registered then no reclaim can be made at all.

Note. Where the leasehold is very long, say 999 years, HMRC will almost certainly accept that it is the leaseholder that benefits from the supply and so they can reclaim the VAT on improvements.

A reciprocal arrangement

One of our subscribers, who was planning a £500,000 (plus VAT of £100,000) extension, found themselves caught by the trap mentioned above. They approached HMRC for advice and it indicated that it might challenge the subscriber’s claim for VAT on the construction work. The risk was too great for our subscriber and so they proposed a solution. They would pay for the building work in return for the landlord not increasing the rent to reflect the extension. Plus, the landlord would reimburse the tenant some of the cost in the event that they sell or transfer the lease before it expires.

Trap. The suggested scheme creates more problems. While it would increase the chances of our subscriber legitimately recovering the VAT on the building work, the subsequent rent-free occupation of the extension counts as a VATable supply. A value would have to be put on this and VAT charged by our subscriber to the landlord, who, because they are not registered wouldn’t be able to reclaim it. Out of the frying pan etc.

Elect and register

While the landlord might be a little reluctant, the relatively simple solution is for our subscriber to persuade them to opt to tax the property and register for VAT. The landlord can then have the building work done, recover the cost by recharging it to our subscriber, plus VAT, which can then be reclaimed.

Tip. HMRC is happy to allow tenants to reclaim VAT on repairs even where they might include a minor element of improvement. However, where the improvement is significant you need to discuss the VAT position with your landlord to ensure that the arrangement allows one of you to recover the VAT.

This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.