VAT on break payments: to pay or not to pay?

A recent judgment from the Scottish Court of Session has considered the impact of HMRC’s Revenue and Customs Brief 12 (2020) (“RCB 12/20” published in September 2020) on break fees in leases. We have previously discussed the uncertainty RCB 12/20 has created in the real estate industry in our article here. 

Ventgrove Ltd v Kuehne and Nagel Ltd

In Ventgrove Ltd v Kuehne and Nagel Ltd the provisions of the tenant’s lease entitled them to terminate their lease on payment of a break fee of £112,500 “together with any VAT properly due thereon”. The tenant exercised their option to terminate in February 2021 and made a payment of £112,500; however, the tenant made no payment in respect of VAT.

The issue arose as to whether the lease had been validly terminated. The landlord stipulated that it was not validly terminated following HMRC’s change of policy in RCB 12/20 which set out that termination payments now fell within the scope of VAT. The Court considered whether any VAT was properly due on the break payment. Prior to RCB 12/20 this would have been a simple answer as HMRC’s policy was that no VAT applied.

Further guidance from HMRC on VAT treatment of termination payments

On 25 January 2021 HMRC published further guidance stating that HMRC would only apply their updated VAT treatment of termination payments (as set out in RCB 12/20) from an unspecified future date, but that in the meantime businesses could either follow the new policy set out in RCB 12/20 or continue to follow the old rules (ie. treat termination payments as outside of the scope of VAT). Notably in this case, the break payment was made in February 2021. Therefore, when the payment was made, adopting the position set out in RCB 12/20 was optional, not compulsory. Using this reasoning, it was the tenant’s argument that no VAT was due as there was no obligation to charge it at the time. Ventgrove’s argument was that HMRC policy was simply guidance and thus VAT was due.

It was the Court’s opinion that the wording “together with any VAT properly due thereon” meant any VAT properly due to HMRC. The purpose of this wording was to ensure that if the landlord had to account to HMRC for VAT on the £112,500 then this VAT would be paid by the tenant on top of the break fee. The wording was not included to enable the landlord to “get a windfall payment” (which would occur if the landlord charged VAT but then did not need to account for it to HMRC).  The Court’s clear view was that the VAT wording should not be used as a tool to frustrate the break option.

The Court therefore concluded that, at the date of exercise of the option, no VAT was properly due on the break fee as a result of HMRC’s published statement at that time.

MEO and Vodafone Portugal

Interestingly, the Court distinguished this case from the CJEU cases of MEO and Vodafone Portugal which are cited in RCB 12/20 as the reason for HMRC’s change in approach.  The Court considered that the CJEU cases related to compensation payable for a failure to complete the minimum contractual term and that this was not the same situation as a contractual entitlement to bring a contract to an end after a specified period upon payment of a fee. In this case, the lease was not terminated prior to expiry of a minimum period but instead at the end of such a period.

Conclusion

The judgment raises interesting questions regarding the validity of HMRC’s broad interpretation of the  CJEU decisions. Whilst the Court of Session’s decision is not binding on English courts, it will be persuasive. We will have to wait and see whether this judgement affects HMRC’s guidance when it is updated.