Commercial landlords routinely incur overhead costs on their rental properties, which, in addition to the rent, they would like to charge on to the tenants. The three most typical examples are things like buildings insurance, business rates, and utilities. When recharging such costs, the question of whether VAT should be added often arises, and can be a thorny issue where any VAT charge will be an irrecoverable cost for the tenant (e.g. because it is not VAT registered).
In these circumstances, a policy of playing it safe and not charging VAT can backfire if HMRC later find it should have been, as the tenant may be reluctant to accept any VAT charge by then. In this article, we look at the two-step approach that can be taken to determine whether VAT should be added to the recharge.
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, and with the business rates, is the landlord’s name on the rates demand, or is the tenant the rateable person? Similarly, is the customer name shown on the utility bill that of the landlord or the tenant?
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 separate supply from the rents, 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 means the landlord is simply looking to be reimbursed for funding the tenant’s cost. 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, we now need to check 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 on the rents.
It should be noted that, regardless of the option to tax position, the recharge of insurance, rates, or utilities is actually an additional supply of rent. It cannot be treated as an onward supply of insurance, rates, or utilities, because the landlord is not itself an insurer, local authority, or utility company.
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 utilities) 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).
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 the utility account customer?” 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.
By Steve Allen