Dispute Resolution

Surveyors will be familiar with the idea that VAT isn’t normally an issue in the settlement of dilapidations claims.

If a claim is settled by the payment of money, the settlement sum is normally treated as a payment of damages for breach of the lease. The general approach taken by HMRC is that VAT is not due on damages payments. That in turn means that VAT is often not something which has to be covered in settlement agreements.

But as ever, the devil is in the detail. There are a couple of areas where VAT can become relevant in the settlement of a dilapidations claim.

Settlement before lease expiry

One situation is where a dilapidations claim is being settled before lease expiry. There may be a risk in some situations that HMRC will consider the payment to be a vatable supply to replace the performance of repairing obligations by a payment of money. That is in contrast to settlement after lease expiry. After expiry, repairs cannot normally be carried out and any payment is likely to be based on acceptance that the lease has been breached. In that situation, the notion that a payment is truly damages for breach of contract is relatively uncontroversial. But if a payment of money in place of performance of the works is agreed prior to lease expiry, parties and their advisers should consider the risk that VAT may be due on the payment.

Landlords can guard against this risk if they take precautions in the settlement agreement. They can insist on a provision in the settlement agreement to the effect that, if HMRC levy VAT on the settlement sum, the tenant will be liable for that VAT. That should be acceptable to the tenant if the tenant is registered for VAT.

The settlement agreement could also include a provision that the tenant will only be liable for any VAT if they are supplied with a valid VAT invoice.

VAT may be more of a problem where the tenant is not VAT registered (e.g. an individual who is not making taxable supplies for VAT purposes) or is using the property for the purposes of a VAT exempt business.

VAT on works

Another potential VAT issue arises where the landlord has not opted to tax the property for VAT purposes. If breach of the repairing obligation results in the landlord carrying out works, VAT will be due on the cost of those works, including professional fees.

That VAT will not be recoverable from HMRC.  It can then become a loss for the landlord to claim against the tenant.  You should therefore always check the VAT position of the landlord before preparing your schedule or agreeing a settlement.

Donald Muir

Managing Associate at Brodies LLP
Don is a member of the Property Litigation team, covering all forms of property disputes, principally those arising from ownership, leasing and burdens.
Donald Muir