Article.

Beware of Uncharitable Tenants

12/12/2017

At a glance

Head of Tax, Alex Barnes, has recently been published in Estates Gazette looking into the potential tax implications on landlords when letting to charities.

Christmas is not the time for nasty shocks. This hasn’t, however, stopped some charities from delivering unwelcome news to landlords. In a number of cases in which properties have been let to charities for several years, those charities have only now, often following a change of advisor, sought to disapply their landlord’s option to tax. This will give the landlords real cause for concern that they could be subject to an immediate clawback of VAT by HM Revenue & Customs (“HMRC”) and to ongoing worries that some/all of the VAT they incur going forward in respect of their property will be irrecoverable from HMRC. So how does this problem arise and is there anything that can be done to avoid it?

Disapplication of the option to tax

Many landlords opt to tax their properties to enable them to recover VAT incurred in connection with the purchase, letting, maintenance and sale of the property. Opting to tax does result in VAT being charged by landlords to tenants in addition to rents, but, for most tenants, the VAT cost will just be a cashflow cost with the only real cost being the additional stamp duty land tax that is payable on the VAT.

Typically, an option to tax can be disapplied only by a purchaser or a tenant prior to the making of any sale or letting of a property.  Landlords and sellers will therefore normally have some advance warning of a potential disapplication. This gives landlords and sellers time to appraise the implications of the disapplication and, in some cases the opportunity to build any adverse VAT costs into the rent/sale price. Where a charity takes a lease of property it, however, has the ability to disapply its landlords’ option to tax at any point during the letting, giving the landlord little opportunity to counter any adverse VAT costs it encounters as a result of the disapplication. The disapplication will only occur if the charity is using the building solely for a relevant charitable purpose (RCP) and not as an office.

What is a RCP?

The use of a property for a RCP means use by the charity otherwise than in the course or furtherance of a business or as a village hall or similarly in providing social or recreational facilities for a local community.

What does “solely” mean?

HMRC interpret this to mean at least 95% and this figure can be used where the landlord and tenant agree. Given that most landlords are unlikely to agree to their option to tax being disapplied, it is open to landlords to insist that that the relevant charity’s use of the property is 100% for RCP before the disapplication can take effect.

Certification

In order to disapply the landlord’s option to tax the charity must certify its intended use of the property to the landlord. There is no required form of certificate and HMRC have indicated that it is enough if the charity just notifies the landlord of its intention. It is strongly recommended that landlords obtain and retain written confirmation of the relevant charity’s intended use. The disapplication will only affect the letting of the property post the disapplication and it is unlikely that a charity could recover VAT incurred on rents prior to the disapplication.

Implications of the disapplication

If a landlord’s option to tax is disapplied then VAT incurred in relation to the relevant property will generally become irrecoverable and the landlord may have a liability under the VAT capital goods scheme (CGS). This liability could be a clawback by HMRC of VAT that it has previously allowed the landlord to recover.

Can the problem be avoided?

Best practice would suggest that, before letting to a charity, landlords establish whether the charity intends to disapply their option to tax. This will enable landlords to undertake a financial appraisal of the VAT implications of a disapplication and to determine whether, commercially, the VAT costs are acceptable and, if not, to either try and build these into the cost of the lease or, possibly to withdraw from the letting.

Appropriate contractual protection should also be added to the lease to ensure that a charitable tenant either cannot disapply its landlord’s option to tax or, if it does, that it agrees to fully indemnify the landlord for any VAT costs incurred by the landlord as a result of the disapplication.

For those landlords currently letting to charitable tenants who are seeking to disapply their landlord’s option to tax, landlords should, in the absence of any contractual protections as referred to above, scrutinise the relevant charity’s use of the property to see if the property is being used 100% for a RCP.  If not, the landlord can insist on charging VAT.

Conclusion

Landlords letting to charities should always ensure that before the lease is entered into, they understand whether the charity intends to disapply their option to tax. If the charity has this intention, the relevant landlord can then consider the commercial implications of this before agreeing to grant the lease.

Appropriate contractual protections should also always be sought by the landlord against any later disapplication to ensure there are no nasty surprises for the landlord at any point during the lease.

Key Tips for Landlords

  • Always ensure you know whether any charitable tenant intends to disapply your option before entering into a lease with them.
  • Make sure you fully understand the VAT implications of any proposed disapplication to enable you to understand the commercial implications of the disapplication.
  • Seek appropriate contractual protection against any disapplication.

Related articles