by Desmond Parte
Is VAT ever payable at the standard rate in a property leasing transaction? “No,” you will reply but, surprisingly enough, the answer can be in the affirmative where reverse premiums are concerned. For example, a lessor who is having difficulty in letting a property may offer an inducement in the form of a sum of money to a prospective lessee. The lessee receiving the sum of money may have, perhaps unknowingly, supplied a “service” to the lessee within the terms of section 3 of the Value Added Tax Act (VATA) 1983, which defines a “supply”. The section reads, so far as is relevant:
- ‘Supply’ in this Act includes all forms of supply, but not anything done otherwise than for a consideration:
- Anything which is not a supply of goods but is done for a consideration (including, if so done, the granting, assignment or surrender of any right) is a supply of services.”
Now read on.
The Gleneagles case
In the VAT Tribunal case of Gleneagles Hotel plc, heard on July 29 1986, the company lost its appeal against an assessment on a reverse premium of £1.4m, the tax being £182,608.
Gleneagles Hotel plc was not obliged by the terms of the underlease granted to it by St Martins Property Corporation to refurbish the hotel, but it had been confirmed in discussions leading up to the grant of the underlease that Gleneagles intended to spend at least £7.5m on such refurbishment. There was a complicated formula for the calculation of the rent to be paid to the landlord based on turnover, and obviously it was in the best interests of both parties to the underlease that the hotel should be brought up to a high standard.
Lord Grantchester QC, the tribunal chairman, came to the conclusion that, in effect, Gleneagles had been paid the money to induce it to spend more than it would otherwise have done on bringing the hotel (now “Le Meridien” in London’s Piccadilly) up to five-star standard. However, Lord Grantchester rejected the contention of the Commissioners of Customs & Excise that the mere acceptance of the underlease of the hotel itself amounted to a supply of services for a consideration. But in the Neville Russell case Lord Grantchester did a U-turn on this question.
The Neville Russell case
In the Neville Russell case, the firm received a sum of £940,000 from Norwich Union, the freeholders of the premises in Bishopsgate, in connection with the renewal of the lease on its existing premises at 246 Bishopsgate and the granting of a lease on the adjoining premises at 266 Bishopsgate which was needed for the purposes of expansion. The £940,000 comprised a payment of £400,000 to refurbish no 266, £300,000 for accepting a lease on no 266 and £240,000 being a reduction in rent payable on the new premises because two floors were surplus to Neville Russell’s requirements and they would have to find a tenant for them. Although Customs & Excise had assessed £122,608 as the VAT element on the entire £940,000 which Neville Russell had received, the VAT Tribunal held that:
- the sum of £400,000 was paid because the firm had agreed to carry out certain work to the premises and therefore it was the consideration for a supply of services;
- the £300,000 was paid to Neville Russell for accepting the lease and it, too, was the consideration for a supply of services; but that
- the £240,000 did not amount to consideration for any supply of services as it was merely a reduction of the rent payable under the lease;
and reduced the assessment to £91,304 being the VAT element of the £700,000.
Effect of standard rating
If both lessor and lessee are registered for VAT and the lessor does not suffer any restriction on the recovery of input tax the imposition of VAT on the consideration should not, generally speaking, cause any problems. However, if the lessor is not registered or cannot recover all his input tax because some of his outputs are exempt he is not likely to be receptive, in the absence of a contractual liability, if the lessee, having been assessed for the VAT by Customs & Excise, seeks to recover it from him.
Standard-rated, zero-rated or exempt?
The Gleneagles reverse premium was standard-rated because it could not be brought within either the provisions for exemption or for zero-rating. For exemption, the provisions are in Item 1, Group 1 of Schedule 6 to VATA 1983 and it will be seen that they apply (with specified exceptions) to “the grant, assignment or surrender of any interest in or right over the land or of any licence to occupy land …”. As an underlessee (or lessee) is not within this provision the supply cannot be exempt. Can it be zero-rated? Unfortunately it cannot, because the zero-rating provisions apply only to a person constructing a building and granting “a major interest” in or in any part of the building or its site — Item 1, Groups 8 and 8A of Schedule 5 to VATA 1983 (the full definition of a major interest is in section 48 (1) of VATA 1983, but broadly it means the freehold or a lease for more than 21 years).
So, having exhausted these possibilities, the only conclusion one can reach once it is decided that a service has been rendered is that the reverse premium is standard-rated.
Other inducement payments
Unlike the instance of a straightforward reverse premium by a lessor to a lessee, there are other circumstances where inducement payments are made which may be standard-rated:
- where an existing tenant pays a sum of money to a prospective tenant as an inducement to take an assignment of a lease; and
- where an existing tenant pays a sum of money to his landlord as an inducement to accept the surrender of his lease.
These types of payment fall more readily than the payment in the Gleneagles case within the wording of section 3(2) of VATA 1983. In the case of the payment at (1) an assignment of a right is a deemed supply of services. Because it cannot be brought within the exemption or zero-rating provisions, the payment can only be standard-rated. It is not easy to see how a payment within (2) is caught by the wording of section 3(2) of VATA 1983, but in the view of Customs & Excise it is. Until someone tests their views by appealing to a VAT Tribunal, the matter can only remain in doubt.
A VAT-exempt reverse premium
One reverse premium which falls within Item 1, Group 1 of Schedule 6 to VATA 1983, and is therefore exempt, is the payment by a lessor to a lessee for the surrender of his lease.
Rent-free periods as an inducement
What is the VAT position if, instead of paying a reverse premium, the lessor gives the lessee a rent-free period? It seems that the rent forgone is the consideration for a supply within section 3, but so far Customs & Excise have not taken the point, at least in my experience.
However, in the Neville Russell case Norwich Union had offered Neville Russell a reduction in rent of “240,000 to reflect the possibility that it would take about a year to find a tenant for the two floors of 266 Bishopsgate which were surplus to Neville Russell’s requirements. Customs & Excise took the view that the £240,000 was the consideration for a taxable supply, but lost their case on this point at the appeal. There is certainly some similarity between this type of consideration and the rent-free period sometimes offered by a landlord to induce a tenant to take a lease.
Until the point is litigated it will remain uncertain, but following Lord Grantchester’s line of reasoning in the Neville Russell case one can at least advise with a greater degree of certainty on rent-free periods now than one could before the case was heard.
Conclusions
The cases discussed above, and particularly that of Neville Russell, have dealt with some of the more common types of reverse premium, and while they provide a measure of guidance on the VAT position each transaction must be examined on its own facts and on the way it is executed. For example, had Neville Russell been directly paid £240,000 rather than it being allowed that sum by way of a reduced rent for the first year of the tenancy, it is thought that Customs & Excise would have won their case on this point also. To use an Americanism, “It ain’t what you do, it’s the way that you do it”.
If both parties to the transaction are registered for VAT — and the payer of the inducement payment is not partially exempt — it does not normally matter too much if VAT is overlooked in the agreements. A (belated) tax invoice can be rendered, and apart from the cash flow effects neither party will suffer the VAT. However, if the payer cannot reclaim the VAT, there could be a problem.
There could also be a problem where the parties are not on good terms after the transaction has been completed or where the payer of the inducement payment has become bankrupt or insolvent.