Tax Lawyers At Irwin Mitchell Warn of Impact On Past And Future Real Estate Transactions

New HMRC guidance [1] on charges described as compensation or early termination fees in a contract have been changed to make it clear that these payments are generally liable for VAT. 

According to Sarah Cardew, Tax Partner at Irwin Mitchell: “Controversially, HMRC advises that any vatable person who has failed to account to HMRC for VAT on such fees must now correct their error as soon as possible.  This makes this change retrospective and places a compliance burden on lawyers.”

Industry bodies are rightly concerned about the retrospective effect of this new ruling, which is a departure from the normal position when a VAT change applies going forward only - and this has caused some debate. The new VAT guidance came in in September but has been largely under the radar to date.

Sarah Cardew, who is also a member of The Law Society’s VAT and Duties Sub-Committee added:

“It is also worrying that it might not be limited to VAT and could represent a change of direction for the government as they seek to recoup revenue after the pandemic.”

“Concern has been expressed to HMRC and we understand that there will be a further meeting with HMRC on the topic”.

The tax Team at Irwin Mitchell has therefore put the following Q&A together for their clients.

Why is this change retrospective?

We understand that HMRC is in the course of significant litigation on this topic based on rulings given by the Court of European Justice (CEJ).  They have also received Counsel’s advice, and this new guidance is the result of that advice.

Does this mean that all payments are vatable?

HMRC does accept that certain payments may still be considered to be true compensation and therefore outside the scope of VAT.  However, HMRC argue that such payments are often called compensation when they are in fact payment for a supply.  

How does this impact on compensation clauses? 

It is now very important to now ensure that the drafting of compensation clauses reflects the true intentions of the parties, and that VAT advice is received at the outset.

What if you have already received a HMRC ruling?

If you have a specific ruling from HMRC saying that fees are the outside the scope of VAT, you only have to account for VAT on such fees received after the issue of this announcement (contained in Business Brief 12/20).

What about dilapidations payments? What should clients do? 

In the past, true dilapidations payments were considered to be compensation which fell outside the scope of VAT. The previous HMRC guidance was that break payments did not attract VAT either however, it seems that HMRC now consider that they do attract VAT, due to the Vodafone case (see below), and change in guidance.  The change is currently retrospective, but is being challenged.

Dilapidations payments now present a worrying conundrum, and it will be very important to be able to demonstrate that the payment was a pure dilapidations payment.  

The CEJ could refer to the Vodafone Portugal [2] case, to re-interpret the intentions of the parties.  In that case, the CEJ ruled that an amount payable in the event of early termination of a contract should be considered to be an integral part of the price which the customer committed to pay to the provider to fulfil their contractual obligations.  Only where there was no direct link between a payment and a supply of goods or services would it fall outside the scope of VAT.

If a client has paid a dilapidations payment inclusive of VAT, depending on the wording of the clause, they could try reclaiming 20% from the recipient.  

How far back does this change apply?

At present, we do not know how far HMRC could look back, but we would advise checking transactions over at least the last four years.  Any amount payable as a result of a termination provision could be caught, irrespective of when that clause was entered into.  So, an agreement could have been entered into ten years ago, but only just have been exercised (or not at all yet).

Does this concern corporate transactions?

Yes, it will impact on commercial and corporate transactions. If a lawyer is undertaking due diligence as part of a share purchase, this point should be specifically checked, and a warranty and indemnity obtained against any unforeseen VAT liabilities (plus interest, penalties and surcharges thereon).

[1] Business Brief 12/20 (2/9/2020) 
[2] C-43/19 (11/6/2020)