COVID-19 has had an unprecedented impact on UK businesses, affecting both landlords and tenants.
Given the government’s moratorium on enforcement of rent payments and the code of conduct for landlords, most recent lease variations have been driven by tenants looking to make short-term cash savings. This has been achieved through rent holidays, reductions, or deferrals, but with tenants and landlords working together to make sure there is some benefit for the latter as well.
For example, in exchange for a rent holiday, reduction or deferral, the tenant may agree to remove a break clause, extend the lease period, accelerate the timing of rent reviews, or agree to fixed future rent increases. These can benefit a landlord in enabling them to demonstrate value to their lenders, while allowing the tenant to better manage their cash flows.
As is the case with exits, not all variations are equal in terms of tax. For both the landlord and the tenant, the direct tax position is likely to depend on the accounting treatment adopted. Under UK Generally Accepted Accounting Principles, the rents receivable and payable will typically be spread evenly in the profit and loss account of the landlord and tenant over the term of the lease. Consequently, the tax cash-flow implications may be very different.
Where rents are simply deferred rather than being reduced or waived, the original accounting – which reflects the relevant proportion of rents receivable or payable for that period, spread over the term – is unlikely to be affected, unless the likelihood of the landlord not being paid at all is sufficient to allow for a bad debt provision. Consequently, the accounts of the landlord may reflect rental income that has not been received, and such income will be taxable on the landlord.
Where a rent-free period or reduced rents are agreed, the waiver or reduction, together with any future increase in rents, is likely to be spread over the remaining term of the lease, which may include any additional years resulting from a lease extension negotiated at the same time. This could again result in the landlord having rental receipts recognised in its accounts and being taxed on these, even when it has not received them.
On the other side of the transaction, the tenant is likely to be accounting for rents payable, for which it can claim a tax deduction, but which it has not actually paid.
In addition to direct tax, it is also important to consider stamp duty land tax (SDLT) and VAT liabilities, which can potentially be triggered at a point where no cash is changing hands between the landlord and tenant.
Where there is a reduction in rent with nothing provided in return, this should not result in SDLT being payable by either the landlord or the tenant. However, achieving a benefit for the landlord in return for the tenant benefit can trigger an SDLT charge for the latter, depending on how this is done. The charge can potentially be significant where credit for the SDLT paid on the original lease is not available.
For example, a rent holiday in return for an extension of the lease term is likely to be treated as a surrender and regrant of the lease, which could lead to an immediate SDLT charge for the tenant. Equally, the tenant’s agreement now to a fixed future rent increase can also trigger an immediate SDLT charge for them where it happens within the first five years of the original lease.
A lease can also effectively be extended by the removal of the tenant’s break clause in exchange for an immediate rent-free period. HMRC has confirmed that this route should not result in any SDLT charge for tenant or landlord.
"This could result in the landlord having rental receipts recognised in its accounts and being taxed on these, even when it has not received them"
Regarding the VAT position, HMRC has recently published some clarification on lease variations. Where the tenant does no more than agree to the variation and continues to pay rent, even at an increased amount in the future or over an extended term, the VAT position will be undisturbed. It is only where the tenant agrees to do something over and above continuing to pay rent, such as undertaking works on the landlord’s property, that any additional supply liable to VAT over and above the rent payments will be regarded as having been made.
The tax position can therefore be complex. It will be important to give some thought to the tax consequences of the alternative routes at an early stage, as business are unlikely to be able to afford a day one tax charge for renegotiating the terms of a lease in the current environment.
Prof. Sara Wilkinson FRICS, Dr Gill Armstrong, Dr Kusal Nanayakkara, Mark Willers FRICS, Prof. Jua Cilliers and Dr Robert Fleck 08 December 2023