...Today Sana Ikhlaq and Rachel Belinfante from Irwin Mitchell’s Real Estate Disputes team examines the issue of VAT on break payments through the Ventgrove Ltd v Kuehne+Nagel Ltd [2022] CSIH 40 case.

This Scottish case confirms that VAT is payable in respect of break payments. Failure to pay any VAT due renders the break notice invalid. Historically, HMRC had taken the view that early termination payments were outside the scope of VAT and therefore tenants were unsure whether or not to pay VAT on their break payments. However there had been some uncertainty around this position which this case clarifies.

Facts

Pursuant to a lease made between Ventgrove Ltd, (the “Landlord”) and Kuehne+Nagel Ltd (the “Tenant”) the Tenant had the right to terminate the lease by exercising a break option after five years. In order to exercise the break, the Tenant was required to provide notice and pay a break premium of £112,500 “together with any VAT properly due thereon”. The Landlord had opted to tax the premises.

The Tenant exercised the break option and paid the break premium of £112,500 to the Landlord. The Landlord refused to accept that the break option had been validly exercised as the Tenant had failed to pay the VAT of £22,500. In the first instance case, the Court of Session (Outer House) gave judgment in favour of the Tenant, holding that break payments were outside the scope of VAT and therefore the break option had been validly exercised.

The Court of Session (Inner House) found that VAT was properly due and that HMRC was entitled to demand it. Therefore the Landlord would have had the legitimate expectation that HMRC would collect it.

The VAT treatment of termination payments had been considered by the Court of Justice and following these cases HMRC had published guidance in Revenue and Customs Brief 12 (2020) entitled “VAT early termination fees and compensation payments”.

The guidance had been postponed at the time that the Tenant paid the break premium, however this postponement was only in relation to businesses that had an established practice of treating break payments as outside the scope of VAT. The Landlord was not such a business. Therefore it would not have had the legitimate expectation that HMRC would treat the payment of the break premium as falling outside the scope of VAT.

Comment

There has been a great deal of uncertainty around the VAT position in relation to early termination fees but this case and the HMRC guidance now provides welcome clarification.

On the topic of break options, as a general rule, the pre-conditions attached to a break option must be complied with strictly for them to be satisfied. Therefore, when it comes to making payments in circumstances where tenants are exercising their break options, it would be judicious to pay VAT in any event or at the very least seek legal advice on this issue.