The starting point is straightforward: residential lease extensions are exempt from VAT. The complication arises on commercial properties and mixed-use buildings. Where the freeholder has exercised the option to tax over the property, supplies relating to that property — including lease extension premiums — are generally standard-rated at 20 per cent. This means the leaseholder pays the premium plus VAT, which can materially increase the cost of the extension.
However, the position is not always that simple, even where an option to tax exists. Anti-avoidance provisions can disapply the option in certain circumstances. Where the leaseholder intends to use the property for exempt purposes, the option to tax may be automatically disapplied, which changes the VAT treatment entirely. Partial exemption calculations, capital goods scheme adjustments, and the interaction with TOGC treatment can all affect whether VAT is actually chargeable and, if so, whether the leaseholder can recover it.
The option to tax is a decision by the property owner to charge VAT on supplies relating to a property that would otherwise be exempt. Once exercised, it applies to all supplies of the property until it is revoked. In the context of a lease extension, if the freeholder has opted to tax the building, the lease extension premium will usually be standard-rated. The leaseholder needs to understand this before agreeing the premium, because the recoverability of the VAT depends on their own registration status and the nature of the supplies they make from the property.
Where a building has both residential and commercial elements, the VAT treatment of a lease extension may need to be apportioned. The commercial element may be standard-rated while the residential element remains exempt. The apportionment basis needs to reflect the actual use and cannot simply be applied on a floor area basis without further analysis. Getting this wrong means either overpaying VAT on the residential element or failing to account for it on the commercial element.
In some cases, a lease extension is structured as a surrender of the old lease and the grant of a new one rather than a simple variation. The VAT treatment of a surrender and re-grant can differ from a straightforward extension. Where the freeholder has opted to tax, this distinction becomes important because the surrender may itself constitute a supply with its own VAT implications. The VAT analysis needs to follow the legal structure, not the commercial intention.
Where a commercial lease transaction forms part of a transfer of a going concern, it may fall outside the scope of VAT entirely. TOGC treatment means no VAT is charged on the transaction, but specific conditions must be met — including that the buyer must be registered for VAT and intend to carry on the same kind of business. TOGC is relevant where an entire commercial interest, including the lease, is being transferred rather than simply extended. Incorrectly applying TOGC treatment where the conditions are not met creates a VAT liability that was never charged or collected.
We confirm the VAT position of the lease transaction before terms are agreed. We check whether the option to tax has been exercised and whether it applies to the specific transaction. We advise on the recoverability of any VAT charged, the partial exemption implications, and the correct treatment for mixed-use apportionments. We work alongside your solicitor and, where relevant, your existing VAT adviser to ensure the position is consistent across all parties involved in the transaction.
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