HM Revenue & Customs (HMRC) published a briefing note last autumn (Revenue and Customs Brief 12 (2020)) which provided that compensation paid and payments made for the early termination of a contract (which, in the context of property transactions, includes a lease) are liable to VAT at the standard rate.

This note reversed HMRC’s previous position, which was that payments described as compensation were outside the scope for VAT because they were not paid under the terms of the underlying contract.

It captures (amongst many other things) the payment of a penalty for triggering a lease break option, the payment of a contractual exchange deposit held as stakeholder where the buyer fails to complete, the contract is rescinded and the deposit is forfeited, liquidated damages under a development agreement and possibly even dilapidations payments at the end of a lease term. As at the date of this article, the latter is still unclear and pending futher clarification from HMRC.

The requirement to charge VAT applies irrespective of whether or not the property in question has been opted to VAT.

It was originally envisaged that the changes outlined in the briefing note would have retrospective effect. This resulted in many businesses and their advisers making representations to HMRC.

HMRC, having taken further advice, has since stated that it will no longer apply the changes retrospectively. Instead, they will now come into effect on 1 February 2021.

Revised and more detailed guidance is being worked up which will seek to address the many unanswered questions of the business community. The revised guidance will (hopefully) also set out more clearly the implications for the property and construction industries. Watch this space!

Postscript

HMRC updated its brief on 25 January 2021 to state that, following communication from businesses and their representatives, the updated VAT treatment of early termination fees and compensation payments will now apply from an unspecified future date. HMRC has further stated that it will "shortly" issue revised guidance and a new brief to explain what businesses need to do.

Please note that this information is provided for general knowledge only and therefore specific advice should be sought for individual cases.

For further information, please contact Philip Mundy