Today HMRC issued Revenue & Customs Brief 11/20 providing their comments on the VAT and SDLT position. This commentary is limited, but is in line with expectations.
With many commercial premises being locked down and tenants facing financial distress, landlords have been agreeing rent-free periods, rent reductions and rent deferrals. These can have VAT, corporation tax and Stamp Duty Land Tax (SDLT) impacts on both the landlord and tenant.
Due to current restrictions, many offices, shops and other commercial buildings are standing empty with tenants unable to use the buildings and most facing substantial losses of income. A significant number of tenants have been in discussion about reducing, deferring, or suspending entirely their rent during this period.
Property is a long-term investment and many landlords are accepting that this may be the best strategy available to them. However, to safeguard their investment, landlords may require the tenant to agree to something in return for any ‘rent holiday’. This can have tax consequences for both parties.
Agreements are taking many forms, but three options seem to be the most popular.
Firstly, there is the fairly informal route with the parties agreeing certain rents do not need to be paid on time, or at all. In some cases, this has been achieved by moving to a turnover-based rent.
The impact on profits will feed through to both parties’ corporation tax returns, but otherwise where the change merely relates to the timing or non-payment of the rents there are limited tax impacts of this approach.
When the tenant entered into the lease, the SDLT charges would have been calculated by reference to future higher rents. Although these have reduced, it will not be possible to obtain an SDLT refund.
Where the lease is converted to a turnover-based rent, the SDLT and direct tax position will depend on whether the change amounts to a variation of the existing lease or whether the change is sufficient to mean that as a matter of property law, there has been a surrender and re-grant of a lease.
Where the lease is treated as varied and no payments are made directly for the variation of the lease then for SDLT purposes the variation is treated as an acquisition and disposal of a chargeable interest and SDLT will be calculated accordingly. Where consideration is also paid directly for the variation, then the variation is treated as the acquisition of a chargeable interest so subject to SDLT. It would also be subject to VAT if the landlord has opted to tax.
From a direct tax perspective, where the lease is varied and no payment is made directly for the variation then the impact should be limited to the quantum of the rent payable (and its associated deduction) and the timing of recognition in the accounts.
Where there is a surrender and re-grant of the lease, there are SDLT reliefs which should apply meaning that the leases do not count as consideration for one and other. There is also overlap relief in respect of the rent payments, where SDLT has already been paid under the original lease. However, this relief can only reduce the rents to zero for the purposes of the calculation, so if the new lease has lower rents due, it is not possible to claim a refund for the earlier SDLT paid. For direct tax purposes, a surrender and re-grant will result in a capital gains disposal event and depending on the length of the lease in place, this may well be a wasting asset. Where the lease is used by a trading business it should, however, be possible to roll-over any gain realised into the new lease granted so no cash tax impact. Alternatively it is possible to apply ESC39, provided the qualifying conditions are met, which means that no disposal event takes place at the grant of the new lease, instead the leases are treated as merged. Where the original lease was less than 50 years, a calculation of the ‘unwasted’ base cost up to the date of the new lease will need to be undertaken.
Secondly, a landlord may agree to a rent holiday on condition that the tenant waives its right to exercise the next break clause. Arguably this is ‘barter transaction’ for VAT. The landlord is providing consideration by waiving some cash it would otherwise be entitled to, in return for the tenant giving up a right to terminate what might be an onerous lease.
From a direct tax and SDLT purposes, the impact of waiving a right to exercise the next break clause should be limited. Depending on the previous likelihood of that break being exercised, it may well alter the timing of the deductions by the tenant.
If the landlord is providing consideration for a service from the tenant, the next question is what the service is from a VAT perspective. If the tenant is giving up an interest in property, then this is exempt from VAT unless the tenant opts to tax the property.
Finally, some landlords are agreeing to a rent-free period of six to eighteen months, provided that the tenant extends their lease for the same period. This would normally require the existing lease to be surrendered and a new lease granted.
In these circumstances, the documentation more clearly implies that there is a barter transaction, as the tenant is giving up one land interest in return for another. The surrender of the first lease to the landlord would be exempt, unless the tenant opts to tax.
As noted above, there is a specific SDLT relief for surrenders and re-grants of leases. Although the landlord will be receiving the rents over a longer period, there is not recalculation of the SDLT charged on the original lease.
The accounting for this may be complex. Any premiums, rent-free periods or other inducements that were being amortised over the life of the lease will now have to be accounted for when this lease is surrendered. Although no money is changing hands, there could still be an accounting profit or loss as a result. In addition for corporation tax purposes, there will be a capital gains disposal event, although as noted above roll-over relief may well be available.
Although the treatment of rent-free periods at the commencement of leases is now well established, rent holidays in the middle of leases have not needed to be considered on this scale so far. With other priorities at the current time, it may be many months before HMRC can provide their view on this.
Landlords will also need to aware as due to the spreading of rent free periods over the life of the lease, they may well find themselves with taxable income having not received any cash rent.
In the meantime, many landlords and tenants are taking a prudent view. Tenants who are normally able to recover all of the VAT they incur have been exercising the option to tax to ensure that any transaction they may have made is not exempt and they can preserve full VAT recovery. Landlords and tenants have been issuing VAT-only mirror invoices to each other for the amount of any rent reduction.
To discuss the position further please contact Adam Cutler, VAT Director, or Caroline Fleet, Property Tax Partner, or your usual Crowe contact.
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