by Ian Marsh
When, following the introduction of VAT on commercial property transactions, the Stamp Office made plain that it would charge duty not only on the rent passing under a commercial lease but also on any VAT charged on that rent, many complained of double taxation.
Their cries of anguish must be all the louder now, for in its statements of practice SP6/91 and SP11/91 the Inland Revenue has decreed — for there has assuredly been no change in the law — that duty must also be paid on VAT not charged on such rent. That is to say, where rent under a commercial lease is not subject to VAT from day one, but the landlord makes no promise (in any enforceable manner) not to charge VAT in future, duty will be charged as if VAT were payable … because it might one day be so!
But that is not all, for the rate of this additional duty will depend not upon the length of the lease, nor indeed upon the level of the passing rent, but on the somewhat arcane point of whether the VAT which may become payable on that rent will itself be rent (which may well depend on which precedent the lawyer favours and, perhaps, on whether he has read this article or others like it).
If rent it be, VAT will be subject to duty as rent, on the usual scales. If not, it will be charged to duty as a series of periodical payments, ie the whole of the VAT — at current rates — which might be payable over the life of the lease (or the first 20 years if the lease is for some longer term) will be charged, without discount, at 1%.
The difference can be dramatic. Take, for example, a lease for 25 years at an initial rent of £1m and no premium. Depending entirely upon how prospective VAT is dealt with in the lease, the duty payable will be:
(a) £20,000 if VAT cannot be charged by the landlord;
(b) £23,500 if VAT can be charged and is treated as rent; or
(c) £55,500 if VAT can be charged but is not treated as rent.
Few landlords reserve VAT on rent, so common practice (at least, common practice until now) would be likely to trigger duty of £55,000 — 5.5% of initial rent, compared with the 2% which the parties might reasonably be expecting.
Of course, while the rate of duty on rent increases with the term of the lease, the duty on periodical payments hits a plateau once the term reaches 20 years, so that the gap between the two gradually decreases for longer leases. Indeed, for leases of more than 100 years it is positively beneficial (to the tune of 0.7% of initial rent!) for VAT not to be treated as rent, but that is of little comfort to the typical institutional tenant.
Such a tenant’s first thought will be to persuade his prospective landlord to covenant not to charge VAT on the property. After all, the landlord must have decided not to charge VAT in the immediate future (or this problem would not be in issue) and there would seem to be no immediate downside in his committing to that course for the future. No downside, that is, save for a fetter on his freedom of future action which many a landlord will resist on principle or concede only at a price. The tenant, for his part, must weigh his immediate, one off, stamp duty saving against the possible effect of the guaranteed “VAT free” status of the property at rent review.
Clearly, those tenants who cannot secure VAT-free status must press for VAT to be expressly reserved as rent — it is not sufficient to provide for VAT to be recoverable “as if arrears of rent”. That, of course, would be quite contrary to the tenant’s normal practice, which is to keep “rent” to a minimum, lessening also the risks of distress being levied on the property. But whereas outgoings, such as service charges, are highly variable and prone to dispute, VAT on rent (should it ever become payable) will be quite certain in amount and quite uncontentious.
A tenant has little to lose in reserving VAT as rent, his only clear downside coming when, in hard times, he pays his rent proper (to avoid the bailiffs calling) but withholds the VAT element until a section 146 Law of Property Act 1925 notice, or perhaps a writ, arrives through the door. The landlord, for his part, should be quite content with this treatment, since it extends the remedies available to him to enforce payment of the VAT.
What then of existing leases? They will have been stamped on grant and future rent reviews will generally be recorded so as to avoid further duty. Such leases should then be of no further interest to the Stamp Office. But that is not the end of the matter for if, as seems likely, VAT has not been reserved as rent in such a lease neither will it be reserved as rent in any hypothetical lease which falls to be considered on rent review. The tenant’s valuer may, therefore, seek a shaving from the reviewed rent on the grounds that a real tenant taking the hypothetical lease would ask for, and get, VAT reserved as rent and so avoid an excessive Stamp Duty charge.
Whether the Stamp Office’s approach to this issue is sound is, most certainly, open to argument and, in an ideal world, would be challenged sooner rather than later. Unfortunately, in the real world, few deals can bear the cost (in time or money) of such a challenge and landlords, tenants and their advisers will inevitably acquiesce in this new practice and, as the author has done here, learn to make the most of it.
Landlord — Drafting lease 2 — 99 years
Reserve “VAT on rent” as rent in its own right.
Tenant — Amending Lease 2 — 99 years
Review draft lease to ensure minimum necessary stamp duty. If landlord will not covenant not to charge VAT, tenant should ensure that VAT is reserved as rent.
Long lease — over 100 years
A slight stamp duty saving is possible if VAT is not reserved as rent. However, landlords’ desire to have certainty as to the remedies available for recovery of VAT may outweigh the stamp duty benefit to the tenant of treating VAT as a periodic payment.
Rent review
The lease should be examined to ascertain what duty would be chargeable on grant of the hypothetical lease. If this differs significantly from the duty chargeable on comparable transactions organised in a tax-efficient manner, an adjustment to the level of the new rent may be appropriate.
The parties should also ensure that they do not inadvertently create a stampable rent review memorandum.
