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Steve Allen of VAT Advisers Ltd considers the important issue of VAT on tenant recharges for commercial landlords.

Introduction

Commercial landlords regularly incur costs on their properties that they recharge to their tenants. Typically, they are seemingly non-VATable costs relating to insurance, rates, and upkeep of the common areas of the property. Whether VAT should be added to the recharges is an age-old problem, and is an issue that HMRC often look at during VAT inspections. The recent  Tribunal case of ‘OM Properties Investment Ltd’ (TC00752) again highlighted the difficulties associated with such recharges, so this article is intended to provide some useful guidance on how to decide whether VAT should be applied.

In the Tribunal case concerned, the landlord, OM Properties Investment Ltd (‘OM’), had six commercial rental properties that were opted to tax, and had been treating its recharges of building insurance as exempt. OM had taken out a single buildings insurance policy through its brokers whereby each tenant was individually provided with a certificate of insurance which named OM. The premium was paid by OM and then recovered as a matching sum by direct debit out of the tenant’s bank account.  Not unreasonably, OM thought that, as the tenant was named in the policy, it was a block policy under paragraph 2.5 of VAT Leaflet 701/36/02. HMRC disagreed that the recharges were insurance, and as the properties were opted to tax, assessed for output tax on the basis that they were additional taxable rent payments. Unfortunately, the Tribunal held that only OM was the insured, and that it had acted to insure the buildings because it was liable to do so. The tenants had merely covenanted to reimburse OM’s insurance premium. Since the recharges were not exempt insurance, the Tribunal agreed with HMRC that they were subject to VAT as a result of the options to tax. 

Given the clear difficulties associated with these costs, what practical steps can landlords take to decide whether the recharge is subject to VAT?  In short, there are two steps that can be taken as follows:

Step One - Who does the Cost actually Belong To?

The first thing to check is whether the cost is even the landlord’s to begin with. In the case of buildings insurance, is the landlord the insured party on the relevant policy, or is it the tenant?  For business rates, does the landlord’s name appear on the local authority demand, or is the tenant actually the rateable person?  Similarly, with a recharge for the upkeep of common areas, does the lease stipulate that the landlord is responsible for such costs (and is able to recover them via a service charge)?

Where the answer to the question is “the landlord”, the cost does actually belong to the landlord. As such, its recharge to the tenant is an additional supply to the rent, and, depending on the outcome of Step Two below, might be subject to VAT. 

Clearly, if the answer to the first question is “the tenant”, then the cost is proper to the tenant, and  the landlord is simply looking to be reimbursed for funding the tenant’s own costs.  In these circumstances, the recharge can be treated as a ‘disbursement’, which means it is not subject to VAT, regardless of the outcome of Step Two (in other words, Step Two can be ignored).

Step Two – Has the Property been Opted to Tax?

Having established that the cost belongs to the landlord, a check should now be made on whether the property has been Opted to Tax. This should be a simple question to answer, because if it has been Opted to Tax, VAT will have been charged (or else should have been charged!) on the rents.

It should be noted that in these circumstances, regardless of the Option to Tax position, the recharge of insurance, rates, or upkeep costs is actually an additional supply of rent. It cannot be treated as an onward supply of insurance or rates, because the landlord is not itself an insurer or local authority.  

As the recharge is effectively rent in another name, it follows that where an Option to Tax has been taken to add VAT to the main rents, any recharge of insurance, rates, or upkeep would also be subject to VAT.  Conversely, where there is no Option to Tax, the recharge is then free of VAT (i.e., it is exempt).

Summary

Remember, the primary fact for landlords to establish when considering if VAT should be added to a recharge is whether the cost is actually theirs. Specifically, they should ask themselves “Am I the insured person, the rateable person, or upkeeper of the common areas of the property?” If the answer is “yes”, VAT will be chargeable where an Option to Tax exists (otherwise exempt). If the answer is “no”, the cost will be proper to the tenant, and can be treated as a VAT-free disbursement.