You own a commercial property but don’t have a tenant. To attract one you’re offering a financial inducement – a cash lump sum or a rent-free period. What’s the VAT position for you and the prospective tenant?
Tough times
Finding a tenant for commercial property, especially in the retail sector, has become more difficult with the uncertainty caused by coronavirus. There are one or two tricks landlords can use to entice prospective tenants; cash payments (known as reverse premiums) and rent-free periods. The VAT consequences of each are similar but quite tricky.
Rent holidays and reverse premiums
A rent-free period (sometimes referred to as a rent holiday) is self-explanatory. A reverse premium is a payment you make to a prospective tenant to sign a lease. It’s called a reverse premium because usually it’s the tenant who pays an up-front amount (a premium) to the landlord for the lease. After some titanic battles in court HMRC eventually conceded both arrangements were outside the scope of VAT, but only in very specific circumstances. It almost immediately had to concede further ground because its approach didn’t sit comfortably with the courts’ decisions. Tip. In most circumstances you and the tenant can forget about VAT in respect of rent holidays and reverse premiums. However, it can come into play where the tenant gives you something in return for the reverse premium or rent holiday.
What counts as “something in return”?
Normal obligations required by a lease, e.g. for the tenant to maintain and keep the property in a good state of decoration, do not affect the VAT position. However, if you ask for something not normally required of a tenant in return for paying them a reverse premium or granting a rent holiday it counts as a supply. For example:
- structural work (repairs or additions) that improves the property. However, usual obligations under a repairing lease or fitting out the property at the start of the lease to make it suitable for use in the tenant’s business aren’t supplies
- works for which the landlord has responsibility under the terms of the lease
- occupying the property as “anchor tenant”. That is, moving into your property for the purpose of making it or neighbouring properties more attractive to future tenants; and
the tenant agrees to move out of a property on terms set by you, e.g. because you want to develop or use the site they occupied. - VAT consequences
- If the tenant is making a supply in return for the reverse premium or rent holiday, and they are VAT registered or required to be registered, they must impute VAT on its value.
Example. If you offer a rent holiday worth £7,200 in return for the tenant carrying out structural repairs that you, as the landlord, would normally be expected to pay for, they must treat £1,200 of the amount (£7,200 x 20%/120%) as VAT and pay it to HMRC on their next VAT return. Trap. This might not seem an obvious disadvantage as you’ll still get £7,200, but it will make the rent holiday that much less attractive to the tenant, which partly defeats the reason for granting it. Tip. If you haven’t opted to tax the property (that is, charge VAT on the rent) doing so means you can reclaim the VAT the tenant imputes in the reverse premium or rent holiday. That way you can overcome the trap above by offering a greater inducement without it costing you any more.
Rent holidays and reverse premiums are typically outside the scope of VAT. But if the tenant agrees to do something in return, e.g. make structural repairs, VAT applies. As a result the tenant, if VAT registered, will have to pay HMRC part of the financial incentive you gave. You can work around this if you’ve opted to tax the property.
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.