You may be aware that HMRC are reviewing the VAT guidance issued in September 2020 in Revenue & Customs Brief 12/20 VAT early termination fees and compensation payments. HMRC have confirmed that any VAT changes will not be applied retrospectively and instead will be applied from 1 February 2021.
When the revised guidance is published, we understand it is likely to state that dilapidations payments are subject to VAT, if the landlord has opted to tax, on the grounds that they represent a fee which the tenant has to pay to the landlord if the tenant has not kept the property in the appropriate state of repair as required by the lease. In other words, dilapidation payments are additional consideration payable by the tenant under the lease.
Clearly this is not how dilapidations actually work in practice, since they are damages for breach of a repairing obligation in a lease rather than simply a fee payable to the landlord, and all the representative bodies including the BPF, LSS, VPG and others have been pointing this out to HMRC. Nevertheless, HMRC may not accept that dilapidations payments should continue to be outside the scope of VAT.
This means that we could be moving to a situation where VAT becomes chargeable on dilapidations payments from 1 February 2021, and this should be taken into account in current transactions.
Please get in touch if you have transactions which may be affected.