Dilapidations Payments: no longer VAT exempt?

Currently, dilapidation payments made under a commercial lease are VAT exempt. However, in its recent “Revenue & Customs Brief 12/20”, HMRC issued proposed new guidance that indicates that there could be a change to the VAT treatment of dilapidations payments in the near future.

If the proposed changes were given effect, the VAT treatment of dilapidations would most likely mirror the VAT treatment of the underlying lease. So, if the landlord opts to tax, 20% VAT would apply to the dilapidations payments. If the landlord does not opt to tax, the dilapidation payments would be VAT exempt. (Where a landlord undertakes repair works having not opted to tax, they should nonetheless pursue any (irrecoverable) VAT from the dilapidations payments payable by the tenant.)

HMRC has confirmed that the proposed changes to the VAT treatment of dilapidations payments would not apply retrospectively. 1 March 2021 is the earliest date on which it is thought the changes would take place. So, in the case of an existing leases, it is likely (although not certain) that dilapidations payments made after 1 March 2021 would be subject to VAT. Payments made prior to 1 March 2021 are unlikely to be subject to VAT.

Whether HMRC’s proposed changes ultimately take place will largely depend on the outcome of the ongoing consultation involving a number of professional bodies.