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Early Termination Fees & Compensation

7th Apr 2022
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The Scottish Court of Session tried to unpick the VAT legislation and changing guidance on early termination fees and compensation in the case of Ventgrove Ltd v Kuehne & Nagel Ltd [2021] CSOH 129.

A lease included a break option which provided for a payment of £112,500 “together with any VAT properly due thereon.” The question arose as to whether VAT was “properly due.”

There was no dispute that the landlord had opted to tax the property, so VAT was due on the periodic lease payments.

The Court reviewed HMRC Brief 12/2020 and internal guidance at VATSC05910, VATSC05920, and VATSC05930, the text of which are included within the decision. Brief 12/2020 followed two decisions of the European Court; Meo (C-295/17) and Vodafone Portugal (C-43/19). These decisions concluded that, where customers terminated contracts early, compensatory payments represented further consideration for taxable supplies. The Brief did not announce an immediate change in policy, but flagged a future change, which was deferred further in January 2021. This proved significant since the break option was triggered on 27 February 2021. HMRC guidance at VATSC05920 states that the new policy applied where “the original contract allows for such a termination.” I am uncertain that the European Court decisions support such a statement. And the Court of Session agreed with me: “that is not the same situation as a contractual entitlement to bring a contract to an end after a specified period upon payment of a fee.”

Readers will know that the technical question remains unclear and unresolved (see HMRC Brief 2/2022). If you are involved in drafting legal contracts, do take due regard to this current situation.

The Court was clear that, under the provisions prior to the dispute, VAT would not have been properly due. Para 20 invokes the VAT and Duties Tribunal decision of Lloyds Bank plc: "the Commissioners agree that if the option for determination or right of early determination...had been included in the original leases, the Commissioners would have followed their policy not to treat this as a taxable transaction......The Tribunal accepts... that it is the Commissioners’ present policy not to treat the exercise of an option to terminate within an original lease as a taxable transaction, although, as that policy is based neither on a provision of law or on decided authority, it does not bind the Tribunal."

Para 25 of the decision highlights a further error. The ‘defender’ had argued that VAT was due “under HMRC policy.” This cannot be true. VAT is due as determined by law. Any question of law is for a Court to determine not HMRC!

VAT affects the majority of business transactions. Disputes between parties will often include questions of VAT. Assume nothing!



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