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The current economic downturn is piling on the pressure for many businesses.  Tenants may be seeking to delay or reduce the rent or even to dispose of the lease.  What tax traps should the parties be aware of?  Can a landlord squeeze additional cash flow benefits from its existing lease arrangements?

Renegotiating lease terms
 Any number of variations could be agreed to a lease, some of which will result in a deemed surrender of the existing lease and a regrant of the lease on its new terms.  There are a number of potential traps.
  • There is a relief which removes or reduces the SDLT which would otherwise be payable by the tenant on the re-grant of the new lease (including on a deemed surrender and regrant) but there are conditions for that relief to apply.  In general, it will not be available if the original lease was not subject to SDLT e.g. because it was subject to stamp duty or because the tenant previously claimed a relief which is no longer available.
  • The arrangement between the parties could amount to mutual supplies being made for VAT purposes (a “VAT barter”) e.g. a reduction in rent in return for the tenant carrying out some work to the property.  Both parties need to ensure that any VAT barter is recognised and the correct amount of VAT is invoiced, accounted and reclaimed.  Missing a VAT barter could give rise not only to a liability to HMRC for interest and penalties but also to fund the VAT itself if it cannot be recovered from the other party e.g. due to insolvency or because the deed of variation has not been drafted correctly.
  • If the original lease was zero-rated, e.g. a lease to a care home operator then a surrender and re-grant of the lease could give rise to a significant VAT liability for the landlord under the capital goods scheme.  Generally, this will only apply to buildings that are less than 10 years old but it can catch landlords who didn't grant the original lease.
Disposing of the lease

If a tenant simply cannot continue the lease then the tenant may seek to surrender or assign the lease.  Again, lots of tax issues could arise but the following should be borne in mind:

  • The tenant will not be able to obtain a refund of any SDLT paid on the grant of the lease.  It may be possible to arrange an assignment of the lease which would usually result in a SDLT saving for the incoming tenant.  The outgoing tenant may be able to negotiate a share of that saving.
  • In some situations the assignment of a lease is treated as if it was the grant of a new lease to the incoming tenant, who will have to pay SDLT on the rent due under the remainder of the lease.
  • An incoming tenant may well be paid a reverse premium by the outgoing tenant to accept the assignment.  The outgoing tenant should note that such a payment is likely to have a more beneficial corporation tax treatment for the incoming tenant than a reverse premium received from the landlord for the grant of a new lease.  Accordingly, the outgoing tenant may be able to share in some of that benefit by reducing the reverse premium.
  • If the tenant is not able to recover all of the VAT it incurs then it will likely incur a VAT cost on assigning the lease and paying a reverse premium to the incoming tenant.
  • On a surrender, if the property is not opted and the tenant can recover at least some VAT then the tenant would be better repairing the property rather than making a dilapidations payment.  A dilapidations payment to the landlord would have to include the irrecoverable VAT to be incurred by the landlord on repairing the property but the tenant will be able to recover some (or all) of the VAT if it repairs the property.  The opposite considerations will apply where the tenant cannot recover all of the VAT it incurs and the property is opted for VAT by the landlord.
Improving cash flow for the landlord
Defer payment of VAT
VAT payments due between 20 March 2020 and 30 June 2020 can be deferred until 31 March 2021 without incurring interest or penalties.  This is effectively an interest free loan equal to the VAT due.  There is no need to notify HMRC but the VAT return has to be submitted by the usual date and any direct debit to HMRC should be cancelled.
Any VAT reclaims and refunds will be made in the normal way by HMRC during this period.  VAT payments due after 30 June 2020 have to be paid as normal. 
Defer VAT invoicing
If a landlord issues a VAT invoice before it receives rent then it crystallises its VAT liability to HMRC whether the tenant pays or not.  If the landlord issues a rent demand (but not a VAT invoice) then the VAT is only due when the rent is actually paid.  Many landlords already do this but any landlord that does not should consider doing so.
Claim VAT bad debt relief
Where the landlord has accounted for VAT on amounts which the tenant has not paid, the landlord should bear in mind the conditions for claiming bad debt relief, which can be claimed for amounts which are unpaid for 6 months provided the landlord writes off the debt in its accounts. The claim can be made in the first VAT return due after the conditions are met.
Vary rent collection date 
If the rent is being deferred to assist the tenant with cash flow then consider changing the rent payment date so that it is collected at the start of a VAT quarter allowing the landlord to retain the VAT for the maximum period of time before paying it to HMRC.
Of course, tax is only one consideration in a lease renegotiation but there are opportunities for landlords and tenants.  Please contact Melanie List or Michael Surry to discuss how we can help.