HM Revenue & Customs has released very helpful guidance confirming that it does not consider that a number of commonly agreed landlord and tenant lease concessions should be classed as “barter transactions” for VAT purposes. During the coronavirus outbreak in the UK there has been a marked increase in lease concessions being given to tenants in exchange for landlord-favourable lease variations. The classification of such arrangements as barter transactions has had potential VAT implications for both landlords and tenants and has caused a considerable administrative headache to all parties at a time when such arrangements need to be entered into quickly to assist tenants struggling during the Covid-19 period.
What is a barter?
Where transactions are entered into in payment for one another rather than for monetary consideration this is defined as a “barter” for VAT purposes. Each party’s supply to the other constitutes the consideration they are providing, in return for the supply made to them, under the “barter” principle. This means that even where no monetary consideration is being paid the parties can be treated as making a supply for VAT purposes.
What is VAT charged on?
VAT is charged on the money’s worth value of the supply. How easy this is to calculate will be fact specific. In most barters, the value of the supplies is equal as the parties are unconnected and acting at arm’s length. In the Example (below), the parties may agree that the value of the rent-free period is equal to the net rents that would have been charged had the rent-free period not been granted and so agree that the undertaking of the landlord works has the same value as that of the rent-free, ie they are exactly equivalent.
However, valuation of barters can be more complicated for landlords and tenants. VAT law requires the parties to charge VAT based on the subjective value that the parties ascribe to the consideration for their respective supply. This is different to market value. It looks at what value the landlord ascribes to this supply to this tenant (and vice versa). There may be situations where the parties have different opinions on the value that they are providing, but they should be limited. Does either party actually pay VAT?
In most barter transactions, the value of the supplies will be equal. If both supplies are standard rated (including as a result of an option to tax) and the parties agree the supplies have equal value, they will simply exchange VAT invoices (ie in that way record the transaction without any money changing hands). This becomes merely an administrative matter (albeit an important administrative matter).
However, if the supply by the tenant is of land, not all tenants will have opted to tax the property and so their supply in a barter would be exempt. If a tenant has not opted to tax the property it will have to actually pay VAT to the landlord. In those circumstances, at the very least, that will be a cash flow cost for the tenant.
What is the impact of the new HMRC guidance?
The new guidance has been introduced following discussions between HMRC and various industry bodies. It provides welcome clarification that certain commonplace lease variations agreed to by tenants for rent concessions etc should not be considered as taxable supplies. The updated guidance is helpful in relation to the numerous transactions that are taking place in the market in response to the challenges the pandemic presents for landlords and tenants, however its application is (helpfully) not limited to Covid-19 related transactions.
The guidance confirms that the following situations will not constitute a barter for VAT purposes:
- where a landlord gives a rent-free, rent reduction or rent holiday and the tenant is doing nothing in return and there are no other changes to the lease;
- where, as part of the arrangements, the tenant agrees to extend the term of the lease, enter into a reversionary lease or agrees to a variation to the break clause in the existing lease, whether by removing that break clause or pushing out the date on which it can be exercised; or
- where the tenant is taking a new lease with new terms.
In the above situations the parties do not need to treat the transaction as a barter. HMRC guidance confirms that variations where the outcome is that the tenant does nothing more than agree to pay rent for an extended period are not a supply by the tenant to the landlord. This follows the long-standing VAT principle that agreeing to be a tenant and to pay rent is not treated as consideration provided to a landlord for the grant of a lease.
It should be noted that outside of variations to break rights there are still a number of landlord and tenant deals where the VAT barter regime is relevant. For example, where a tenant agrees to carry out works for the landlord in return for a lease concession (as in our example below), land swaps and on mutual releases of rights of light.
Example
A landlord owns a run of five retail and office units. His asset management team have previously identified that the rear servicing arrangements and fire escapes could be improved to the benefit of all the units, but this has required capital expenditure that was not then available. A tenant proposes works to reconfigure its store to provide enhanced rear access, altered escape, storage and to comply with Covid-19 requirements generally. Agreement is reached that the tenant will be able to do these works as permitted alterations under the lease and that it will also carry out wider works to enhance the service areas and remaining fire escapes at the same time, under the same works contract. In exchange it will receive a rent-free period of six months under its lease from Jan 2021.
Phil Anderson is a partner and Alexandra Tuck is a senior associate at CMS
