Tax implications of lease renegotiations and improving cashflow

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?

• 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.

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.