VAT Club: Land and property

Tenant lease incentives: Are you paying the right VAT?

As the commercial property leasing market continues to favour the tenant, landlords are increasingly offering incentives to their current and prospective tenants to enter into property leases.

However each agreement will be different depending on the particular incentive being offered. Consequently, the VAT accounting treatment of each incentive may also be different, an issue which is often overlooked.

Landlords frequently offer inducements or contributions to tenants taking a lease and, typically, do so in order to maintain a certain headline rent. A lower rent would give the wrong signal to other prospective tenants and could reduce the value of the property and the potential sale price. These incentives might be in the form of a rent-free period, payments for the surrender or reverse surrender of a lease, contributions towards fitting out or refurbishment costs, cash inducements and payments made to anchor tenants. All of these incentives have specific VAT treatment and to manage VAT risk it is important that VAT is accounted for correctly.

Here we outline the VAT treatment of some common incentives:

  1. Landlord pays the tenant an incentive to undertake building work
    In this case, the tenant effectively acts as the landlord's building contractor. This might happen where the building is already in need of repair when the lease is granted, and the tenant agrees to deal with this in exchange for payment. In such a situation, the supply by the tenant will generally be standard-rated.
  2. Tenant carries out fitting out works in exchange for payment 
    A landlord's contribution to fitting out works for which the tenant is responsible is not consideration for a supply, and is outside the scope of VAT.
  3. Landlord pays tenant to surrender or terminate a lease 
    In this situation, the payment by the landlord can be consideration for a supply by the tenant unless the payment can be treated as compensation and, therefore, outside the scope of VAT. Any supply by the tenant in surrendering the lease will be exempt from VAT unless the tenant has opted to tax the property. If the tenant has opted to tax the property, the supply will be standard rated unless, under anti-avoidance rules, the option to tax is dis-applied.
  4. Tenant agrees to pay landlord to terminate the lease 
    This situation is known as a reverse surrender. In this case, there will be a supply by the landlord to the tenant and the payment will be exempt from VAT unless the landlord has opted to tax. However, sometimes the payment by the tenant to the landlord could be outside the scope of VAT if the payment is regarded as a dilapidations payment.
  5. Landlord gives a prospective tenant a cash inducement or rent-free period.
    Usually, if nothing is given in return by the prospective tenant, there is no supply for VAT purposes. However, if the tenant provides a benefit to the landlord in return, the VAT liability of the supply will depend on the nature of the benefits provided, which could, for example, involve undertaking improvements or repairs to the building or acting as an anchor tenant (in order to attract other tenants), in which case the supply will be standard rated.

It is clear from the situations above, that each incentive has a different VAT impact. As such it is important to review the contractual position as that will play a key role in ascertaining the appropriate VAT liability of the incentives. Ensure your finance team are involved in discussions to ensure you stay on top of your VAT obligations. 

Previous updates

Land and property: Supplies related to land, 3 March 2014
Louise Scholey, Senior Indirect Tax Manager
, considers the place of supply rules in relation to land.  She explains how diverse views between EU Member States could lead to double taxation and increased compliance costs. Watch the video to ensure the right amount of VAT is paid.

Land and property: Examples on how to avoid VAT pitfalls, 3 December 2013
Louise Scholey, Senior Indirect Tax Manager
 considers VAT tax points and shares some examples of pitfalls to be avoided to ensure the right amount of VAT is paid at the right time.

Land and property: Mixed use developments, 24 June 2013
Jane Stacey, Senior Indirect Tax Manager outlines the VAT issues surrounding mixed use property developments ie those which have both commercial and residential elements. She explains the financial impact on developers and how to make possible VAT savings.

Land and property: Incentivising tenants, 23 July 2012

Louise Scholey, Senior Indirect Tax Manager shares some examples where methods used for incentivising tenants could leave you with liabilities that you least expect.