The grant of a lease, and thus the rent payable under that lease, is an exempt supply for the purposes of VAT meaning that no VAT is payable on rent. However, landlords who are VAT registered do have the option of electing to waive this exemption so that they can charge VAT on rent and may choose to do this so they can recover any VAT they themselves have had to pay. Whether VAT is payable on rent is normally ascertained when the lease is granted, but a landlord who has not opted to tax is not barred from doing so in the future. Similarly, if the landlord sells their interest in the property, it may be that the new landlord chooses to start charging VAT on the rent. However, if a landlord has elected to charge VAT it is not possible to revoke this election except in very specific circumstances.

The VAT rate is set to increase from 17.5% to 20% from 4 January 2011 and this will impact on landlords and tenants of leases where VAT is charged. Whether VAT should be charged at 17.5% or 20% depends on (i) the date which is the earlier of the date that the rent is paid or on which a VAT invoice is issued by the Landlord; and (ii) the period to which the rent payment relates.

Rent paid or invoiced in advance

Where rent is paid or invoiced in advance on or before 3 January 2011 VAT will be payable at 17.5%, even if that payment or invoice relates to a period falling after the VAT increase has taken effect. For example if a Lease was granted on 1 November 2010 and rent is paid quarterly in advance on 25 March, 24 June, 29 September and 25 December:

• the rent paid on 1 November for the period from 1 November 2010 to 24 December 2010 will be charged VAT at 17.5%;
• the quarter"s rent payable on 25 December 2010 will also be charged at 17.5%, even though the majority of this quarter falls after 4 January 2011; and
• VAT payable on the rent paid from the 25 March 2011 onwards will be charged at 20%.

However, there are anti-avoidance rules in place to prevent landlords from invoicing large periods of rent in advance to take advantage of the lower tax rate and landlords should take advice if they are considering using such a scheme.

Rent paid or invoiced in arrears

Where rent is paid or invoiced in arrears then the VAT rate is still dependant on the earlier of the date on which the rent is paid and the date it is invoiced. For rent paid or invoiced on or after 4 January 2011 the landlord can charge VAT at 20% on the full amount of rent even if this partly relates to a period before 4 January 2011. However, there are special provisions which mean landlords can choose to charge tax at the lower rate if the rent relates to a period of time prior to 4 January 2011. So if a lease granted on 1 November 2010 and payable quarterly as above but in arrears:

• the rent paid at 25 December for the period 1 November-24 December 2010 will be charged at 17.5%;
• the payment made at 25 March 2011 will need to be apportioned as either rent:
• for the period 25 December 2010-3 January 2011, which will be charged at 17.5%; or
• for the period 4 January -24 March 2011, which will be charged at 20%; and
• VAT payable on rent paid from the 24 June 2011 onwards will all be charged at 20%.

Landlords should be careful when they issue rent demands that they are requesting the correct amount from their tenant taking into account the VAT rate change. They should warn the tenant that additional VAT may become payable, particularly if the tenant doesn"t pay the rent until after 3 January 2011.

Stamp Duty Land Tax

The VAT increase also impacts on the amount of Stamp Duty Land Tax (SDLT) payable by a tenant on the grant of a lease as SDLT is payable on the VAT charged on the rent as well as on the rent itself. SDLT is calculated by reference to the net present value of the rent and when calculating this value VAT will need to be added to the rent at the appropriate rates, as set out above.

Tenants should have paid SDLT taking account of the VAT increase on all leases granted on or after 27 July 2010 and tenants whose leases were granted on or after this date will need to consider whether they have an additional SDLT liability.

Rent Deposits

Landlords who hold a rent deposit from their tenants may also want to consider whether they are entitled to require their tenant to top up the sum held on deposit because of the VAT increase.

For more information regarding the VAT increase and commercial leases please contact the Commercial Property Team on 01159 888 777 or email enquiries@fraserbrown.com