A commercial lease rarely just ends. Money moves in one direction or the other on the way out: a dilapidations payment from a tenant who hasn't kept the premises in repair, a surrender premium to walk away early, or a reverse premium paid by the landlord to persuade someone to take the space on at all. Three payments, three different VAT answers — and HMRC's own position on one of them has moved more than once in recent years, which is exactly the kind of area where a confident assumption is the most expensive kind.
Dilapidations: currently outside the scope of VAT, but it hasn't always been settled
A dilapidations payment compensates a landlord for a tenant's failure to comply with the repair, reinstatement or decoration covenants in a lease — the building isn't handed back in the condition the lease required, so the tenant pays instead. For a long time HMRC treated this as pure compensation, outside the scope of VAT altogether, because it was seen as damages for breach of covenant rather than payment for anything the landlord supplied. Following European case law on early termination and compensation payments, HMRC updated its guidance in 2020 to say that many payments of this kind should instead be treated as further consideration for the underlying supply of the lease, which would have pulled dilapidations into VAT wherever the property was opted. That update caused enough uncertainty and pushback across the property and telecoms sectors that HMRC revisited it, and its 2022 guidance reinstated outside-of-scope treatment specifically for genuine dilapidations. The practical position today is that a straightforward dilapidations payment, properly evidenced as compensation for disrepair rather than for anything retained or supplied, stays outside VAT — but the fact that this moved twice in a few years is itself the reason to check the current guidance before assuming, rather than relying on what was true five years ago.
Where the line can blur is if part of what's labelled a "dilapidations" payment is really consideration for something else — fixtures, fittings or improvements the tenant leaves behind that the landlord has separately agreed to pay for, for example. That element is a supply in its own right and needs its own VAT analysis, not the outside-of-scope treatment that applies to genuine compensation for disrepair.
Lease surrenders: a supply of land, so the option to tax decides it
A surrender is different in kind from dilapidations. Here, a tenant pays the landlord to accept an early end to the lease, and HMRC treats the landlord's agreement to that surrender as a supply of an interest in land in its own right. That means the surrender premium follows the same VAT liability as the rent would have done: standard-rated if the landlord has an option to tax in place over the building, exempt if the landlord has never opted. A landlord who has opted the property needs to charge VAT on a surrender premium in the same way as on rent; one who hasn't opted keeps the surrender exempt, but loses the input VAT recovery that comes with an option in the first place. Getting the direction of the payment and the option to tax status matched up correctly at the point of surrender avoids either under-charging VAT that HMRC later assesses, or charging VAT unnecessarily on a payment that should have been exempt.
Reverse premiums: the tenant is usually the one supplying something
A reverse premium runs the other way: the landlord pays the incoming tenant, typically to secure an anchor occupier for a scheme or to get a difficult unit let at all. HMRC's long-standing position, drawn from case law on inducement payments, treats this as consideration paid by the landlord for a supply made by the tenant — agreeing to take on the lease, fit out and occupy the space, and by doing so support the value of the wider building. That supply by the tenant can be taxable depending on the tenant's own VAT status and registration, in which case the tenant may need to charge VAT on the premium it receives, and the landlord's ability to recover that VAT depends on its own partial exemption position covered in our guide to VAT partial exemption for property businesses. This is the payment direction landlords most often get wrong, because it's easy to think of a reverse premium as simply a discount on rent rather than as the tenant making a supply back to the landlord.
Why the direction of payment and the option to tax both matter
- Dilapidations (tenant pays landlord for disrepair) — generally outside the scope of VAT under current guidance, provided it's genuinely compensation and not dressed-up consideration for something retained.
- Surrender premium (tenant pays landlord to exit early) — a supply of land by the landlord, following the property's option to tax status.
- Reverse premium (landlord pays tenant to take the lease) — generally a supply by the tenant to the landlord, taxable depending on the tenant's VAT position.
The same underlying event — a lease coming to an end or a new one starting — can therefore produce three completely different VAT outcomes depending on which way the money moves and what it's actually paying for. Documentation matters as much as the mechanics: a settlement or surrender deed that clearly separates dilapidations from a surrender premium, and states the basis for each, is worth far more at the point of an HMRC enquiry than a single lump sum with no breakdown.
Common mistakes
- Assuming dilapidations are always outside the scope of VAT without checking whether HMRC's guidance has moved again since it was last checked
- Charging VAT on a surrender premium for an unopted property, or failing to charge it on an opted one
- Treating a reverse premium as a simple rent discount rather than recognising it as consideration for a supply the tenant is making
- Lumping dilapidations, a surrender premium and fixtures payments into one undifferentiated settlement figure with no VAT analysis behind the split
- Not revisiting the Capital Goods Scheme position on a property leaving a landlord's portfolio shortly after a surrender, where earlier VAT recovery on the building may need adjusting
Lease exits are exactly the kind of one-off, high-value event where the VAT treatment is easy to get wrong precisely because it doesn't come up often enough to have a routine answer. If you're negotiating a surrender, a dilapidations settlement or an incentive to bring in a new tenant, our Property Advisory service covers the VAT position alongside the wider commercial terms.
Common questions
Is VAT charged on a dilapidations payment?
Under HMRC's current guidance, a dilapidations payment made by an outgoing tenant to compensate a landlord for failing to keep premises in the repair required by the lease is generally treated as compensation and stays outside the scope of VAT, so it is not added to the amount charged. This followed a period of uncertainty after 2020 guidance suggested such payments might instead be treated as further consideration for the lease and therefore taxable; HMRC's 2022 update reinstated the outside-of-scope treatment for genuine dilapidations specifically.
Does a lease surrender premium attract VAT?
Where a tenant pays a landlord to be released from a lease early, the payment is generally treated as consideration for the landlord's supply of agreeing to the surrender, which is itself a supply of an interest in land. That supply follows the same VAT treatment as the rent under the lease: standard-rated if the landlord has an option to tax in place over the property, exempt if not.
What is a reverse premium and how is it taxed for VAT?
A reverse premium is a payment in the opposite direction: the landlord pays an incoming tenant to take on a lease, often to secure an anchor tenant or fill a difficult unit. HMRC has generally treated this as consideration for a supply made by the tenant to the landlord, such as agreeing to occupy, fit out or enhance the value of the property, which can be a taxable supply depending on the tenant's own VAT position, rather than simply a discount on rent.
Why does the option to tax matter for dilapidations and lease exits?
Where a payment on a lease exit is treated as consideration for a supply of the property itself, such as a landlord's supply on accepting a surrender, that supply takes its VAT liability from whether the landlord has opted to tax the building. An opted commercial property makes the surrender standard-rated; an unopted one keeps it exempt, which in turn affects how much input VAT the landlord can recover on costs connected with the exit.
Kieran Holsgrove is a Director and Co-Founder of Grafene Accounting, the property tax specialist firm based in Liverpool. He advises property developers, investors and landlords across Merseyside, Greater Manchester, Lancashire and Cheshire on tax structuring, developer VAT, SDLT and the long-view decisions that compound over the life of a portfolio.
This article is general information, not personal tax advice, and tax rules change. Your own position depends on facts we cannot see from here — please take advice before acting on anything above.