New rules mean VAT could be payable on dilapidations

New rules mean VAT could be payable on dilapidations

Ben Rennocks, director at Silverstone Building Consultancy warns landlords and tenants to be mindful of new rules on VAT and how the tax may be applied to financial settlements such as dilapidations claims.

What has changed?

On 2 September 2020, HMRC issued updated guidance concerning fees and compensation payable upon the early termination of a contract or lease agreement.  The update to its Revenue and Customs Brief 12 (2020) has potential ramifications for dilapidations settlements in the sense that they are a financial consideration for the supply of goods or services, which are therefore generally liable for VAT.

At present there remains a lot of uncertainty as to whether dilapidations payments now fall within the scope of VAT and we await confirmation as to whether the changes by HMRC could see such claims being subject to VAT in future.

Previously, whether or not VAT was charged on a dilapidations claim was dependant on whether or not the landlord had waived their exemption to tax the property concerned. Until the recent change of practice, dilapidations payments were seen as compensation (a claim for damages by the landlord against the tenant’s outstanding want of repair) and were generally accepted as being outside the scope of VAT. With a financial settlement the landlord accepts payment in lieu of having to appoint consultants and contractors to address the outstanding dilapidations.

How does this affect landlords considering issuing dilapidations claims?

In practice, this means that whereas previously landlords would omit the VAT from a claim, the proposed changes mean that in future, HMRC may seek to recover VAT in relation to the settlement even though it is not related to the provision of goods and services.

HMRC have stated that any change will not be retrospective so taxpayers can carry on with their current tax treatment until a new brief is issued. We understand HMRC originally hoped to have a new brief to take effect from 1 February 2021, but they have still not issued anything formally. It appears that finalising these changes is taking longer than anticipated and opinion within the industry suggests it could take several weeks.

When the revised guidance is published, we understand it is likely to state that dilapidations payments are subject to VAT. Effectively this may mean we will be moving to a situation where VAT becomes chargeable on dilapidations settlements completing after 1 February 2021.

In practice, dilapidations are damages for breach of repairing covenants in a lease, rather than simply a fee payable to the landlord. We understand a number of leading industry bodies have highlighted this to HMRC. Nevertheless, HMRC may not accept that dilapidations payments should continue to be outside the scope of VAT. We fully expect some of the larger claims to be vigorously contested by tenants in court as a result of the proposed rule change.

What you can do to prepare

Pending the issue of formal guidance from HRMC, our advice to landlords is to seek to reserve their position with regard to VAT, particularly if the settlement payment could be made at a later date once the revised guidance has been published.

We have no doubt this will ultimately complicate the landlord’s ability to agree a full and final settlement, but at present there are limited alternatives.

Silverstone Building Consultancy is an established firm of building surveyors and project managers with offices in Leeds and Newcastle but working nationally across the UK. We provide a range of project management duties as well as professional work such as dilapidations, building surveys and schedule of conditions.

If you need expert advice on this or any other building related matters we would love to help. Please contact Ben Rennocks on 0113 3207879 or email: 

New rules mean VAT could be payable on dilapidations

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