VAT on variation and surrender fees?

Lease variation

Your lease may state that you can only trade from the premises with your main business activity. For example, it might specify that a firm of accountants can only use an office building for their accountancy work and not, say, as a restaurant or coffee shop.

If your landlord agrees that you can start a new activity on the property you are renting, they are likely to charge you a fee to vary your lease, which might be subject to VAT.

Option to tax. If your landlord has opted to tax their interest in the building with HMRC, they must charge you VAT on a lease variation fee . In other words, if they charge you VAT on your rental payments, they will also charge VAT on the variation fees.

Tip. If your landlord has not opted to tax, the variation fee will be exempt from VAT.

Tip. If there is doubt about whether your landlord has opted to tax, ask to see a copy of the confirmation letter they received from HMRC when they opted.

Subletting the building?

You may get your landlord’s permission to sublet part of the building to another business or organisation to utilise the space that you no longer need. If so, you must decide whether to opt to tax your own interest in the building and charge VAT on the rent to your future tenants. This will be sensible if your tenants can fully claim input tax on their overheads expenses because VAT will not be a cost to their business. For technical guidance, refer to VAT Notice 742 (see The next step ).

Tip. The advantage of your rental income being taxable is that it will avoid a potential input tax restriction on your own building costs with partial exemption, assuming that your trading business is also fully taxable.

Trap. Once you opt to tax a property, it will remain in place for at least 20 years, so you should consider the possibility of future tenants not being able to claim input tax on their rent, which could restrict your subletting options.

Lease surrender fee?

To exit the building before your lease has expired, your landlord is likely to charge you a surrender fee. The same VAT outcome applies as with the variation fee, i.e. it will be subject to VAT if your landlord has opted to tax their interest.

Dilapidation charge by landlord

Many leases will require you to pay your landlord an additional fee for the costs of “making good” their property, i.e. to restore it to the same condition as when you first took occupation of the building. These fees are usually known as “dilapidation fees” and are not subject to VAT because they are compensatory, i.e. they are not relevant to any taxable supply of services made to your business by your landlord.

Trap. You should not accept an incorrect VAT charge by your landlord just because they have issued a VAT invoice addressed to your business. The legislation is clear that you can only claim input tax on expenses where VAT has been correctly charged in the first place.