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VAT and property: When is a surrender deemed to occur?

Thursday, December 2, 2010

by Nick Ryan

Since the introduction of the new rules for VAT on property there has not been the wealth of transactions or the range of idiosyncrasies in these transactions to fully test the mettle of the new legislation. In these times where the business focus is on the cutting face it is often the case that the back office suffers. Restructuring and reorganisation brings with it the acquisition, transfer and disposal of assets, lack of awareness of the new rules brings with it the potential to apply VAT incorrectly.
One issue that is causing a number of problems for businesses and practitioners alike is that of lease surrenders. I was involved in a transition and pre transition property query recently and was surprised, when contacting my local Revenue office to discuss the decision they had made for the transaction in question, to find that they had not retained copies of the guidelines they had published for the pre 2008 rules nor had they copies of the legislation for these rules to hand. (If anyone has a copy of the original Revenue guidelines then please feel free to send it to me and I can forward it to my local Revenue district for future reference!)
We so readily embraced the new rules we forgot how we would still need the old rules to reflect on and refer to. I digress….
A question often asked is at what point is a surrender of a lease deemed to occur? Firstly we need to understand what is meant by a surrender of a lease.
To understand what a surrender of a lease is we must be first understand the definition of a lease. A lease is an agreement between landlord and tenant for the assignment of a right to occupy a property or piece of land for a given period of time in consideration of a payment of rent. The lease agreement outlines the rights of the landlord, under the terms of the lease, which are to be conveyed, for the period of the lease, to the tenant. For the lease contract to occur there must be a lessor (landlord) who has the right to grant the rights in the land or property under the terms of a lease and a lessee (tenant) capable of accepting these rights. Finally there must be the land or the property in existence to be granted.
The lease will, or may, provide rights to both parties that can either extend the period of the lease or terminate the lease agreement at a time earlier to the lease term agreed. This latter right to terminate includes the tenant’s option to surrender a lease.
The current VAT legislation does not include within it clarification of when a surrender is deemed to have occurred and perhaps this is due to the fact that the actual timing is not, in Revenue’s view, relevant for inclusion in the VAT legislation. Rather it is a legal matter and, once arrived at, triggers the necessity for the VAT rules to then be considered and applied.
Under the old rules Revenue outlined their understanding of the meaning of surrender by a tenant of the remaining lease term to the landlord. The primary meaning would be the invocation, by either the tenant or the landlord, of the terms of a break clause in the lease. Revenue also accepted that surrender also includes the re-possession by ejectment or forfeiture or, where the tenant has abandoned their interest in the property/land being lease and, the failure by the tenant to exercise their option to extend their interest in the property/land. Even at the time of the old rules there is no reference, either in legislation or Revenue guidance, as to at what point this is deemed to occur.
A legal definition of surrender states that it is covers the abandonment of a leased property, or premature termination of a lease, unilaterally by a tenant or with the consent of the landlord. Surrender covers two types, firstly there is an “express” surrender which occurs when the tenant signs a written surrender agreement or, there is an “implied” surrender which occurs when both the tenant and landlord by their actions show that the lease has ended, such as when the tenant vacates the property and the landlord reoccupies it.
If we consider Revenues original guidance in tandem with the above definition then we can reach a position to determine when VAT is triggered.
With the express surrender this is straightforward as both parties are in communication with each other and therefore by formalising the surrender arrangements the requirements to fulfil for the administration of VAT can be applied by both parties under the guidance of their advisors.
For implied surrenders the position is not so straightforward. Where a landlord implements an “implied” surrender either by re-possession or ejectment then they would still look to obtain the required VAT documentation from the tenant confirming:
• The amount of tax due on the surrender and,
• the number of intervals remaining in the adjustment period at the time the lease is surrendered.
The fact that the landlord has implemented an “implied” surrender ensures that the VAT administration and accounting requirements can be met and, at the right time.
The position where a tenant implements an “implied” surrender can differ as, in this instance, the tenant has abandoned their interest in the property. Therefore it is unlikely that the tenant has informed the landlord or that the landlord is aware that the tenant has indeed vacated the property under lease. Here a difficulty arises for the landlord who is obliged to account for VAT on the surrender though does not have the required information from the tenant in order to fulfil this accounting requirement.
In this instance the landlord can only trigger the surrender at the time they become aware the tenant has vacated the property and therefore terminated the lease and, where the landlord takes repossession of the property. This provides for the timing point but then the landlord needs to determine what the tenant’s VAT position was i.e. had they an entitlement to deduct any of the VAT charged on the acquisition of the property being leased. If a VAT 4a/b was utilised at the time the lease was granted then this will facilitate the landlord in determining this point.
The landlord then needs to confirm whether any works were undertaken by the tenant on the property which would meet the definition under the old rules as a further development of the property as this will be important for the onward administration of the capital goods scheme.
This all sounds complicated and open to error. My view would be that the landlord, in this instance, needs to apply a logical approach. The landlord should have the historical information about the property under lease and, based on this information, the landlord can complete the VAT accounting and reporting requirements. For completeness the landlord could, where there is a degree of uncertainty in their level of knowledge or where the landlord suspects that the tenant’s VAT position might lead to a VAT exempt treatment of the surrender, approach Revenue for an agreement to their proposed VAT accounting of the surrender. This latter step would secure the position for the landlord going forward and, where it is concluded that the surrender is VAT exempt, Revenue should concur to a landlord’s request to opt to have the surrender treated as taxable where this provides protection for the landlord. When approaching Revenue I would recommend that there is evidence to show that every possible step has been taken to obtain the historical information required in order to determine the VAT treatment of the surrender. Where there is insufficient information then any basis for the VAT treatment to be applied should have a clear supportive argument.
All in all the key issue for a landlord, and their advisers, in managing the VAT administration of a lease surrender is to determine whether it is an “express” or “implied” surrender. For “implied” surrenders if a logical approach is taken by the landlord involving the compilation of the historical position on the lease then there should be no reasons for concern. Once the position is determined the administration and accounting of the VAT can be managed.