Commercial Property: Whether VAT was payable on a break payment when a tenant terminated its lease (Ventgrove Ltd v Kuehne+Nagel Ltd – 2022)

Where a tenant wished to exercise the break option contained in its lease, was the break payment payable by the tenant to the landlord subject to VAT?

The background

In Ventgrove Ltd v Kuehne+Nagel Ltd [2022], the landlord and tenant entered into a lease which gave the tenant the option to the terminate the lease after a minimum initial period subject, to giving sufficient notice and paying the landlord a break payment of £112,500. The payment was to be made ‘together with any VAT properly due thereon’. The landlord charged tax on the premises.

The tenant exercised its break and paid £112,500 to the landlord. The landlord argued that the break had not been properly exercised as it had not paid the additional VAT of £22,500. Heard in the Outer House of the Court of Session in Scotland, the court found that break payments were outside the scope of VAT and that the lease had been validly terminated. The landlord appealed.

The decision

The Inner House found that VAT was due, referencing earlier cases of MEO v Autoridade Tributaria and Vodafone Portugal v Autoridade Tributaria, both of which found that such payments were subject to VAT. The Outer House had found that these cases compensated landlords for a failure to comply with minimum tie-in periods, as opposed to the instant case which concerned compensation following a tie-in period. The Inner House found that there was no distinction; both payments were made as a result of a tenant terminating its lease early and payments would not have been made if leases had continued.

Following the Autoridade cases, HMRC updated its guidance to clearly state that VAT is chargeable on payments made in respect of early termination of leases, although the effect of such guidance was postponed. In the instant case, the landlord had no legitimate expectation that break payments would be treated outside the scope of VAT by HMRC, and did not have an established practice of treating them as such itself.

Advice and action for landlords

This decision clarifies the treatment of break payments for VAT. Although the position was unclear in this case because effect of the guidance from HMRC was postponed, updated guidance has since been published in Revenue and Customs Brief 2 (2022).