Transitional measures applying to legacy leases

Variation in the length of the term of the lease

Mr L granted a lease to Mr T for 20 years on 1 July 1994. Value-Added Tax (VAT) was properly accounted for on the creation of the lease. On 1 July 2010, a deed of variation was negotiated and agreed between the parties which extended the term of the lease by five years.

The VAT treatment is that the extension of the lease is treated as the creation of a new lease from the date on which the original lease expired (30 June 2014).

When the new lease came into effect on 1 July 2014, there were no VAT implications for Mr L or Mr T. The letting is exempt from VAT and there are no CGS implications for either party.

In this example, assuming there was no development work carried out, there are no VAT obligations on the execution of the deed of variation. This is because, there was no surrender of the original lease and the original lease remained in place.

Reduction in the rent in return for removal of break clause

Mr A granted a lease to Ms B for 20 years on 1 January 2004. VAT was properly accounted for on the lease. The lease contained a break clause at year ten.

On 1 March 2010, a deed of variation was negotiated and agreed between the parties which reduced the annual rent by 25% but also removed the break clause at year ten.

In this example, there are no VAT implications in relation to this deed of variation because there was no surrender of the original lease and the original lease remains in place.

Partial surrender of a lease

ABC Ltd granted a lease to XYZ Ltd for 20 years on 1 January 2006. VAT was charged on the creation of the lease in the sum of €100,000.

On 1 July 2010, ABC Ltd and XYZ Ltd agreed to a deed of variation which meant that 25% of the area covered by the lease was surrendered to ABC Ltd.

In this example, the VAT treatment is that there was a part surrender of the legacy lease. This part surrender is treated as a supply of goods on which VAT is chargeable.

The amount of VAT chargeable is calculated as follows:

(T x N) / Y

T = total tax incurred

N = number of full intervals + 1 remaining in the CGS adjustment period

Y = total number of intervals in the CGS adjustment period

(100,000 x 16) / 20 = €80,000

€80,000 x 25% (area being surrendered) = 20,000

€20,000 was the VAT that was payable by ABC Ltd (the surrender is taxed on the basis of a reverse charge).

Additional area added

D Ltd granted a lease on a warehouse to E Ltd for 20 years on 1 July 2005. VAT was properly accounted for on the creation of the lease.

During 2017 and 2018, D Ltd constructs a new warehouse adjacent to the one occupied by E Ltd. The development is completed on 1 May 2018. D Ltd reclaims the VAT incurred on this development on the basis that it intended to opt to tax the letting.[1]

On 1 July 2018, D Ltd agrees a deed of variation with E Ltd to increase the area covered by the lease to include this new warehouse with the existing lease still to expire on 30 June 2025. An additional €250,000 rent per year is payable under the deed of variation.

In this example, the VAT treatment of this deed of variation is that the original legacy lease is unaffected. The new area covered and the additional rent, which is provided for by the deed of variation to the original lease, is treated as a new lease for VAT purposes.

In order to avoid a claw-back of the VAT reclaimed on the development cost, D Ltd must exercise the landlord's option to tax and charge VAT at the standard rate on the €250,000.[2]