A recent judgment from the Scottish Court of Session considered the impact of HMRC’s Revenue and Customs Brief 12 (2020) (“RCB 12/20” published September 2020) on breach fees in leases. We have already discussed the uncertainty that RCB 12/20 has created in the real estate industry in our article here.
Ventgrove Ltd v Kuehne and Nagel Ltd
In Ventgrove Ltd v Kuehne and Nagel ltd the provisions of the tenant’s lease allowed him to terminate his tenancy on payment of a breakage fee of £112,500″as well as any VAT rightly due thereon”. The tenant exercised their termination option in February 2021 and made a payment of £112,500; however, the tenant has not made any payment for VAT.
The question arose as to whether the lease had been validly terminated. The owner clarified that it was not validly terminated following HMRC’s policy change in BCR 12/20 which stated that termination compensation now fell within the scope of VAT. The Court examined whether VAT was rightly due on the payment for the breach. Prior to RCB 12/20 this would have been a simple answer as HMRC policy was that no VAT applied.
Additional guidance from HMRC on the VAT treatment of termination payments
On 25 January 2021, HMRC issued further guidance stating that HMRC would only apply its updated VAT treatment of Termination Payments (as set out in BCR 12/20) from a date unspecified future, but that in the meantime companies could either follow the new set of policies in BCR 12/20 or continue to follow the old rules (i.e. treat termination payments as out of scope of VAT). Notably in this case, the payment for the breach was made in February 2021. Thus, when the payment was made, the adoption of the position provided for in BCR 12/20 was optional and not mandatory. Following this reasoning, the tenant argued that no VAT was due because there was no obligation to charge it at the time. Ventgrove’s argument was that HMRC policy was merely guidance and therefore the VAT has been from.
The Court held that the wording “as well as any VAT rightly due thereon” meant any VAT rightly due at HMRC. The purpose of this formulation was to ensure that if the landlord had to account to HMRC for the VAT on the £112,500 and then this VAT would be paid by the tenant in addition to the breakage costs. The wording was not included to allow the owner to “obtain an exceptional payment(which would happen if the owner charged VAT but did not need to report to HMRC). The Court’s clear view was that the VAT wording should not be used as a tool to thwart the break option.
The Court therefore concluded that at the date of exercise of the option no VAT was properly due on the severance pay due to the statement issued by HMRC at that time.
MEO and Vodafone Portugal
Interestingly, the Court distinguished this case from the CJEU cases concerning MEO and Vodafone Portugal which are cited in RCB 12/20 as the reason for HMRC’s change in approach. The Court held that the CJEU cases concerned compensation due for non-respect of the minimum contractual duration and that this was not the same situation as a contractual right to terminate a contract after a period determined subject to the payment of a fee. In this case, the lease was not terminated before the expiry of a minimum period but rather at the expiry of such period.
The ruling raises interesting questions regarding the validity of HMRC’s broad interpretation of CJEU rulings. Although the Court of Session’s decision is not binding on the English courts, it will be persuasive. We will have to wait and see if this judgment affects HMRC guidance when it is updated.
The ambiguity surrounding the VAT treatment of severance payments and the possibility that a revised position could be issued by HMRC at any time poses a real problem for the property sector.