The case of Vengrove Ltd against Kuehne + Nagel Ltd ([2021] ScotCS CSOH_129) adjudicated by the Scottish Court of Session on December 22, 2021, revolves around the interpretation of Value Added Tax (VAT) obligations in the context of lease termination. The dispute emerged between Vengrove Ltd ("the pursuer" and landlord) and Kuehne + Nagel Ltd ("the defender" and tenant) concerning the termination of a commercial lease for premises located at Kirkhill Industrial Estate, Dyce. The crux of the matter was whether the tenant was liable to pay VAT in addition to the stipulated sum for exercising the break option within the lease agreement.

The court was tasked with determining whether the Lease between Vengrove Ltd and Kuehne + Nagel Ltd was validly terminated when the defender exercised the break option by paying £112,500 without the corresponding VAT of £22,500. The judgment, delivered by Lord Ericht, concluded that no VAT was properly due on the £112,500, thereby validating the termination of the lease. The decision hinged on the prevailing HMRC policy, which at the time the option was exercised, did not treat such termination payments as taxable transactions. Consequently, the defendant's termination of the lease was upheld, and the pursuer's plea was denied.

Precedents Cited

The judgment extensively referred to previous cases and HMRC guidelines to contextualize the VAT obligations. Notably:

• Lloyds Bank plc v Commissioners of Customs and Excise (LON/95/2424), 1996: Established HMRC's stance that termination options within original leases were not taxable transactions.
• MEO Serviҫos de Comunicaҫões e Multimédia SA v Autoridade Tributária e Aduaneira (C-295/17) and Vodafone Portugal (C-43/19): EU Court of Justice cases that shifted the perspective on compensation and early termination fees, reinforcing that such payments are typically considered taxable as they are remuneration for services.
• Mohr v Finanzamt Bad Segeberg (C-215/94): Highlighted that payments lacking a direct link to a supply of goods or services remain outside VAT scope.

These precedents played a pivotal role in shaping the court's understanding of VAT applicability, balancing both UK and EU perspectives.

Legal Reasoning

Lord Ericht analyzed whether VAT was "properly due" on the £112,500 paid by the defender to terminate the lease. Initially, HMRC's position, as encapsulated in the 1996 Lloyds Bank case, was that such termination fees within original leases were non-taxable. Although HMRC briefly indicated a shift in policy in 2020, this change was suspended in January 2021, meaning the original stance prevailed at the time the option was exercised.

The judge considered whether the phrase "together with any VAT properly due thereon" in the lease implied an obligation for VAT to be paid even when HMRC policy did not treat the transaction as taxable. It was determined that this clause was intended to ensure compliance if VAT were applicable, not to impose an obligation contrary to prevailing policy. Therefore, since no VAT was due under the existing policy, the termination was valid without the additional VAT payment.

Impact

This judgment reaffirms that, unless HMRC policy or law explicitly dictates otherwise, termination fees embedded within original lease agreements may not attract VAT. It underscores the importance of understanding current tax policies and their effective dates. Future cases involving similar termination clauses will reference this decision, particularly regarding the interpretation of contractual language relating to VAT obligations.

Additionally, businesses must stay abreast of HMRC policy changes, especially those influenced by EU Court rulings, to ensure compliance and avoid unintended tax liabilities.

Value Added Tax (VAT)

VAT is a consumption tax placed on a product or service whenever value is added. In this case, the question was whether the fee paid to terminate the lease early constituted a taxable supply under VAT laws.

Break Option

A break option is a clause in a lease that allows either party to terminate the lease before its natural expiration under specific conditions, typically involving the payment of a predetermined sum.

HMRC Policy

HM Revenue and Customs (HMRC) provides guidelines on how VAT applies to various transactions. Policies can change, and the timing of these changes is crucial in determining tax obligations.

Declarator

A declarator is a court order that declares the rights, duties, or liabilities of the parties without necessarily providing a remedy or compensation.

The judgment in Vengrove Ltd against Kuehne + Nagel Ltd serves as a pivotal reference point in understanding how VAT applies to lease termination fees within commercial agreements. By affirming that the option to terminate the lease was valid without additional VAT payments, the court reinforced the significance of existing HMRC policies at the time of transaction. This decision highlights the necessity for businesses to meticulously draft lease agreements and remain vigilant of tax policy updates to ensure compliance and prevent disputes.

Ultimately, the case underscores the delicate balance between contractual obligations and tax regulations, emphasizing that the interpretation of specific clauses must align with prevailing legal and regulatory frameworks.