VAT – Change to the treatment of Compensation and Early Termination Payments impacts property sector – including historic transactions

Updated 21st January 2020

On Friday 18th January, HMRC shared an update on the question of early termination payments.  Whilst there is still a way to go, HMRC now accepts that there should be no retrospection.   They have given a specific comment on dilapidations payments which they consider are further consideration for the underlying supply where the work is noted in the contract.

The update is as follows;

  • HMRC consider that it has an arguable case to not apply this change retrospectively. In light of this, they will not apply the change retrospectively.
  • Instead, the change will apply from 1 February 2021.
  • Where we are already in litigation, HMRC will consider the facts and whether any alteration to the line taken to date is appropriate and communicate that to the businesses concerned.
  • HMRC plan to provide interested parties draft guidance before Christmas for comments, with responses due by 12 January 2021.  They will then consider if any changes are needed and update the guidance and issue a Business Brief before the beginning of February. RCB 12 (2020) will be withdrawn.

In broad terms, HMRC deems that early termination and similar payments will be considered for the supply if they form a cost component to the supplier of making the intended supply available or are broadly equivalent to what would have been charged for that supply. This is consistent with the judgements in MEO and Vodafone Portugal. Where a charge is made which is provided for in a contract, but which is not directly linked to the intended supply, it will be outside the scope of VAT.

The following examples help to illustrate this:

  • Dilapidation payments – (Where contracts require tenants to return the property at the end of a lease in the same condition as when it was first occupied, and if they do not do so the landlord may charge them for the costs incurred in doing that work). These payments are further consideration for the supply where the work is to make good use permitted under the contract.  There is a direct link between the payment and the supply, and there is reciprocity as the tenant has signed up to return the property in the condition they obtained it.  If the tenant had gone beyond what was permitted under the contract then the charge to rectify this would be outside the scope. It would not be for the supply as the landlord had not agreed to the usage and so the necessary reciprocity would not exist.
  • Car Hire – If a payment is required from the customer when a car is written off in the course of hire, the payment lacks the necessary link to the intended supply of car hire, as the supplier does not agree in the contract that the customer can write the car off (even if the contract makes provision for such an eventuality). The necessary reciprocity is not present in order to link the supply and consideration.  The fee for writing off the car is therefore outside the scope of VAT. The same is true of charges for excess wear and tear (that is wear and tear greater than that consistent with normal use of the car in the hire period).

September 2020 update as follows

When HMRC recently issued a Brief setting out changes to the VAT treatment of compensation and early termination payments, the guidance was given in the context of a recent European court ruling relating to cancelling mobile telephone contracts.  Closer inspection, however, highlights the danger from any HMRC or Government announcement of a change in approach – the potential for the change to have an unexpected impact or consequences in other sectors.

Policy Change

Hitherto HMRC’s guidance made clear that when customers are charged to withdraw from agreements to receive goods or services, these charges were not generally for a supply and were outside the scope of VAT.   Most early termination payments have been treated as compensation for the loss of future profit, and therefore not subject to VAT.  However, HMRC has now concluded that these early termination fees should be subject to VAT, because it is considered that the payments represent a charge for the supply of goods or services which a customer contracted for.  HMRC say that most early termination and cancellation fees are therefore liable for VAT – even if they are described as compensation or damages.

Consequences for the Real Estate sector

The Real Estate sector is likely to be impacted significantly by the change in approach.   The new policy raises a concern that VAT is liable to be charged on lease “break payments” / early termination payments whether specified in the lease or negotiated separately between the landlord and the tenant and where the option to tax has been applied.  Other property-related payments made to secure the early termination of long-term contracts including liquidated damages may also fall to be subject to VAT – for example, the payment to a facilities management company to terminate a contract early.  The policy sees a supply rather than outside the scope compensation.

It is also possible for leases and other agreements to terminate early if a particular event occurs such as the customer breaching the terms of the lessor or an associate business calling in receivers. Contracts may stipulate that such events cancel their terms or effectively allow the lessor to terminate as though there had been a breach and require a fee to compensate the lessor. As with other payments envisaged under a contract, this is a further consideration for a supply and will be subject to VAT.

Dilapidation payments have long been treated as compensation for tenants’ failure to meet their lease obligations and outside the scope of VAT.  The new policy does not affect this position, as true dilapidation payments stem from the tenants’ failure to maintain the building during the lease – but it is important that agreements reflect the position correctly and accurately.

Retrospective impact

In a further twist, HMRC’s announcement broke with the normal approach of making changes in tax policy applicable prospectively.  HMRC have set out that they consider that the policy applies retrospectively and requires taxpayers who may not have accounted for VAT on such fees to correct the errors for supplies in the last 4 years.  If taxpayers have had a specific ruling on the point from HMRC (and getting rulings from HMRC is increasing challenging these days), their treatment can change prospectively from the date of the HMRC announcement on 2 September 2020. 

We understand that representations have been made to HMRC in relation to this retrospective tax-grab, on the grounds that taxpayers have a legitimate expectation to rely on HMRC published guidance and fiscal certainty but there is no indication that HMRC will alter that approach.  It could even be seen an opportunistic tax-gathering measure in the current circumstances.

Action required

Given the new guidance, taxpayers who have paid or received compensation, termination payments or similar should review the contractual and VAT treatment and consider an adjustment if appropriate. The VAT team at MHA Henderson Loggie would be happy to provide assistance in that process if required.

Alan Davis | VAT Partner & Chairman |

Allan Easton | VAT Consultant |

Liquidity Support for SME Housebuilders

A £100 million emergency loan fund has been created to support small and medium-sized (SME) housebuilders with liquidity issues due to the temporary closure of housebuilding sites.

The fund is open to applications from existing  SME housebuilders registered in Scotland and complements existing COVID-19 support schemes. The fund aims to:

  • safeguard jobs and protect suppliers
  • ensure a continued supply of homes
  • support post-COVID-19 economic recovery, and
  • retain diversity within the housebuilding sector.

Who can apply?

SME housebuilders which can demonstrate that:

  • they are a non-public organisation that have a business registered in Scotland which has been directly affected by COVID-19
  • they complete five or more homes in Scotland per annum
  • their annual turnover is less than £45 million
  • their business was financially viable before COVID-19
  • funding cannot be secured from existing private banks or other financial institutions or from their own resources to meet liquidity needs, and
  • the business has attempted to secure funding from the Scottish Government, UK Government or other public sector COVID-19 schemes before they have applied to the fund.

How much funding is available and on what terms?

The fund will offer short-term loan funding to applicants to cover COVID-19 liquidity support to their business. Key features include:

  • loans of between £50,000 to £1 million, which will normally be limited to a maximum of 25% of annual turnover
  • fixed interest rates of 2% per annum, and
  • flexible repayment terms, with the option for capital and interest payments to be offset for 12 months – the majority of loans are expected to be repaid within 24 months.

Providing security will help reduce the risk profile of loan funds for the Scottish Government

How to apply

More details on how to apply for the support are available on the website here.

Get in touch

If you have any questions about the liquidity support for SME housebuilders, please get in touch by completing the contact form below.

VAT on new house building: Are there any special rules that apply?

Are you a new house builder and are unsure about the rules & restrictions for VAT?

In this short video Alan Davis, VAT Partner here at MHA Henderson Loggie, shares some insight into the Value Added Tax rules for new house builders.

Covered in this video:

✅ Common misconceptions about VAT for new house builders
✅ What are the VAT restrictions?

If you have any questions about VAT for new house builders, please contact Alan directly at

Edited video transcript

VAT for new house builders

Generally speaking, when I’m advising builders who make new houses, they’re typically aware that there are VAT restrictions on input tax on the costs of building those new builds, but I find very often that the people who are dealing with these points quite often change. You’ll have somebody who’s changed jobs, and the next person will either not be aware that there are restrictions or will forget over time. One of the things I do when I’m talking to them is ensure that they’ve got good systems in place to ensure that everyone’s aware of the implications of VAT and new house building.

Common misconceptions

It’s a common misconception that VAT becomes part of the financial annual audit and that accountants are looking at the treatment of VAT as part of their audit. Historically, I would have thought that was the case as well when I was in HMRC, and that’s not the case. It’s a common misconception. It’s really down to you to focus on VAT and know the rules about what you can recover VAT on and what you can’t. The information in this video is quite general, and so we would always recommend that you take specific professional advice of your own to ensure that you get the VAT position correct.

What are the rules applying to house building?

Well, the main one is the treatment of white goods. You’re restricted from recovering VAT on things like refrigerators, washing machines, dishwashers, and so on. In addition, the treatment of flooring is quite important. You’re not entitled to recover VAT on carpets, but if you lay down a hardwood floor, that VAT is recoverable. Similarly, most new house builders have sales and incentive schemes, for example, part exchange and the extra furnishings, curtains and so on. Each of those have VAT implications and specific VAT treatment. You’d really need to keep an eye on those.

Any questions about VAT for new house builders?

If you’re involved in the construction of new houses or the VAT treatment of the costs of doing so, or if you’ve got questions or comments, please feel free to contact Alan directly at

The information is this video is of a general nature and seeks to highlight some of the issues which could be affecting you and/or your business, including changes to financial regulation and legislation. Viewers should not rely on this information without seeking professional advice on its application in their circumstances.

Blair Davidson

Blair trained and qualified as a Chartered Accountant with MHA Henderson Loggie and currently specialises in providing external audit services to a wide range of medium and large commercial clients across a variety of sectors including motor retail, manufacturing & engineering, healthcare, construction and transport.

Having spent time on secondment with a number of MHA Henderson Loggie’s clients in both the private and public sectors, Blair has practical experience of the commercial environment in which our clients operate.

In addition to his role in audit, he manages a range of accounting and management accounts assignments and is head of the firm’s Property & Construction sector group.