VAT on unpaid rent: a problem for landlords

Many landlords of commercial property charge their tenants VAT on rent. Often landlords will demand rent from tenants in advance, at the beginning of the month, quarter or other period in respect of which the rent is payable.

If a landlord issues a VAT invoice to the tenant when demanding the rent in advance but the tenant does not pay the rent, for example because the tenant is in financial difficulty, then:

  • The VAT rules still require landlord to account to HM Revenue and Customs ("HMRC") for VAT on the rent as shown in the VAT invoice even though no payment has been received from the tenant.
  • Although the landlord may, in due course, be able to make a claim for VAT bad debt relief (to recover back from HMRC the VAT previously accounted for), the landlord will meanwhile be out of pocket in respect of the VAT.
  • Where the landlord has obtained VAT bad debt relief on unpaid rent and the tenant (or perhaps its administrators) subsequently pays some or all of this rent, then part of the VAT bad debt relief previously obtained will have to be paid back to HMRC.

Fortunately, however, in respect of a tenant whose ability and/or willingness to pay rent appears to the landlord to be somewhat doubtful, the landlord can both (1) avoid having to account to HMRC for VAT on the rent before the tenant pays and (2) avoid the need to claim VAT bad debt relief on unpaid rent.

Special VAT rules for rent payable under a lease of real property

There are special VAT rules for rent payable under a lease, which are significantly different from the normal VAT rules. In particular, under these special VAT rules, the only triggers for the landlord incurring VAT on the rent are either:

  • Issue of a VAT invoice in respect of the rent; or
  • Receipt by the landlord of rent from the tenant.

Neither the landlord's making the premises available to the tenant nor the tenant's occupation and enjoyment of the premises will, of themselves, trigger any VAT liability for the landlord in respect of the rent. The due date for payment of rent is also, of itself, not a trigger.

Using the special VAT rules: issue by landlord of "non-VAT" invoice

Where there is a material doubt whether the tenant will pay all or some of the rent by the due date for payment, there is a simple solution for the landlord, namely:

  • When the landlord issues (in advance) its demand for rent, the document issued by the landlord states expressly on its face "this is not a VAT invoice" and some key requirement for a valid VAT invoice is intentionally omitted (typically, the landlord's VAT registration number). The demand should, however, still show as payable the correct amount of VAT on the rent;
  • If (but only if) the landlord receives some or all of the rent from the tenant, then the landlord issues a formal valid VAT invoice to the tenant in respect of the precise amount received.

Example

If the full rent (including VAT) for the period is £180, but so far the landlord has received only £120, then (assuming that the standard rate of VAT remains 20%) the landlord will issue a VAT invoice for rent of £100 plus VAT of £20. If and when the landlord receives the outstanding balance of £60, then the landlord will at that time issue a further VAT invoice for rent of £50 plus VAT of £10.

The VAT consequences of the above arrangements are that:

  • The initial issue by the landlord of the rent "demand" does not trigger any VAT because it is (intentionally) not a VAT invoice;
  • The receipt (or, if more than one, each receipt) of rent by the landlord will trigger VAT for the landlord on the amount actually received;
  • Where the tenant is carrying on a taxable business, subsequent issue of the formal VAT invoice by the landlord will permit the tenant to obtain credit from HMRC for the VAT; and
  • (Since the landlord never has to account for VAT on unpaid rent) VAT bad debt relief becomes irrelevant.

Practical points

The landlord will need to explain the new invoicing arrangements to the tenant. However, provided the landlord issues its formal VAT invoice promptly after receiving rent from the tenant, both landlord and tenant should find the arrangements relatively simple to operate.

The suggestion above involving non-VAT invoices only works because of the special VAT rules that apply in respect of rent payable under a lease of real property: issue of "non- VAT" invoices will not generally work to avoid incurring VAT in respect of supplies of other goods and services.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.