Munster’s first independent VAT consultancy practice providing specialist VAT and Indirect tax advisory, assurance and interim management support services to owner managed businesses, small & medium enterprises, accountants and legal practices.

VAT and Deeds of Variation to Leases: Key VAT issues to consider

Tuesday, February 15, 2011

by Nick Ryan

Although the property sector is quiet transactions are still occurring though these transactions are often the result of the current economic downturn and businesses needs to cut costs. The changes to the VAT on property rules are often forgotten as are a number of the secondary measures introduced after the implementation of the changes in July 2008. One such measure is the application of VAT in connection with deeds of variation to leases.
In general terms this is where the substance of an existing lease agreement is altered to an extent that there is a fundamental change. It can cover a number of issues including where the space covered by the lease is either reduced or increased, where the level of rent charged is changed subject to a rent review or change in the terms of the lease or, where the parties concerned change.
As with any alteration of an arrangement the VAT position and treatment might also be effected and as we can be dealing with properties spanning the old rule and new rule regimes then care should be taken to ensure the correct VAT treatment is applied to avoid the potential for error.
Not all deeds of variations for leases will have a change in the VAT treatment or an additional VAT obligation but there is a need to examine any deed of variation and assess the VAT issues to ensure no changes or additional VAT obligations are required. One example of a deed of variation where VAT can be of issue is where a property in question under the terms of a lease is either reduced in size or an additional increase in space is taken then VAT becomes an issue.
Where there is a partial surrender of a lease and that lease is a legacy lease then there is a requirement to calculate the VAT charge due on the part surrender using the formula provided by Revenue, Total tax by the number of full intervals remaining (plus 1) divided by the total number of intervals. This formula is then applied to the percentage of the unit being part surrendered. Once this calculation has been completed the tenant can provide the VAT calculation to the landlord to account for the VAT correctly.
The position is more complex where additional space is being taken by the tenant, for instance where a tenant looks to occupy an additional floor in an office block. Although the original lease in place is being changed under a deed of variation and the terms of the lease will remain in place for the existing area leased, a new lease is essentially created for the additional space. As this occurs under the VAT and property regime where all commercial property leases are exempt unless the landlord opts to tax the lease greater care needs to be taken in considering the VAT treatment to be applied.
For instance the landlord may want to opt but the tenant may not be fully taxable and therefore does not want to bear the additional VAT cost. Landlord and tenant may be connected. The landlord may have undertaken a major redevelopment of the property covered by the additional lease, or it might be a new build, and therefore has a major VAT bearing cost to consider. As you can see taking an additional area can create major VAT headaches for both parties if not managed correctly.
If you are dealing with a transaction that includes either of the above then we would recommend that specialist VAT advice be sought. We can assist you in advising your clients by providing the impartial expert opinion on the VAT issues to be considered and provide the VAT assessment of the various scenarios together with planning solutions for both parties to consider. Where the VAT is properly managed then both parties can be rest assured that there will be no headaches arising down the line.
In our next issue we will focus on VAT and “forced sales”. In the meantime if you have any areas you would like us to focus on or any questions then please contact us.