The recent case of Ventgrove Limited v Kuehne + Nagel Limited  CSIH 40 has highlighted the importance of parties to a lease understanding their obligations and ensuring they are properly exercised. The repercussions of not doing so can be considerable.
Kuehne+Nagel was the tenant under a 10-year lease starting in December 2016. The lease was subject to a break option which entitled the tenant to terminate the lease after five years. The break option was subject to a payment to the landlord of £112,500 “together with any VAT properly due thereon”.
The tenant attempted to exercise their break option and in doing so made payment of £112,500 without any additional VAT. The tenant argued that conversations with the landlord gave them the impression that a payment excluding VAT would be accepted.
The landlord raised court proceedings arguing that a payment of £135,000 was due (£112,500 plus VAT at 20%). As the break option conditions had not been fulfilled, the lease had not been validly terminated.
The Outer House of the Court of Session decided that VAT was not applicable on break option fees and so the lease had been validly terminated. The landlord appealed that decision.
On appeal, the Inner House of the Court of Session held that the VAT payment was properly due and so the break option had not been validly exercised.
The court held that the sum paid to the landlord as the break option fee formed part of the consideration for the lease of the premises, making the fee just as taxable as the rent.
The Value Added Tax Act 1994 provides that a grant of interest over a right in land is generally exempt from VAT. However, the same Act provides that a person may opt to tax any land, in which case VAT is applied. In this case, the landlord had opted to charge VAT on the break option fee.
Lord Tyre noted that if the court were to treat the break option fee as compensation falling outside the scope of VAT then it would not reflect the “economic reality of the transaction”.
The case will now go to a hearing on the evidence to ascertain whether or not the landlord’s actions before/after payment of the break option fee will prevent them from relying on their argument that the break notice is invalid.
By submitting an invalid break notice, a tenant may find themselves bound by the terms of the lease for the remainder of the period. That could have a significant financial impact. This case is a reminder to both landlords and tenants of the importance of ensuring that parties understand their obligations and that break notices are served properly and in line with the provisions of the lease.
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