Dilapidation payments and VAT

8th January 2021

HMRC issued Revenue & Customs Brief 12 (2020) last year which set out HMRC’s view that, as a result of certain European Court cases, certain payments which had previously been regarded as outside the scope of VAT as being payments of compensation or liquidated damages were, in fact, consideration for the original supply of goods or services to which they related. They also indicated that they would be looking at such payments retrospectively which clearly raised the possibility that organisations could face a VAT assessment even though the payments had been treated in line with HMRC’s previous policy.

A number of representations were made to HMRC and, as a result, they have indicated that the original Revenue & Customs Brief will be withdrawn and a new one will be issued. HMRC’s revised policy will take effect from 1 February.

In broad terms, HMRC considers that payments will be consideration for a supply if they are a cost component to the supplier of making the intended supply available or which is broadly equivalent to what would have been charged for that supply. They give two examples to illustrate their view.

  1. If a payment is required from a customer who writes off a hired car, then HMRC would continue to accept that this payment is outside the scope of VAT as the hire firm has not agreed to the customer writing off the car even if the contract makes provision for such an eventuality.
  2. However, where a contract requires a tenant to return a building in the same state as it was when it was first occupied, and a tenant fails to do so, HMRC take the view that any dilapidation payment is further consideration for the original lease, and either taxable or exempt depending on whether the landlord has opted to tax the building or not.

This is a major change as previously all dilapidation payments were regarded as outside the scope of VAT.

For a tenant who is unable to recover all of their VAT they potentially now face an irrecoverable VAT charge on any dilapidation payments they make to their landlord.

Options to tax

As a result of COVID-19, HMRC had previously announced a relaxation in the time limit a person has to notify HMRC of an option to tax.

The normal position is that an option to tax should be notified within 30 days of the decision to opt. When COVID-19 hit, HMRC announced an extension for decisions to opt made between 15 February and 31 March 2020. This was initially extended to allow such options to be notified by the end of June. This was later extended to the end of October and, on 6 January 2021, HMRC have now announced that such options should be notified by the end of March.

Phil Salmon

Partner, Co-Head of VAT
+44 20 7969 5611
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