Guidance on VAT and rent free periods
Rent Free Periods and Sums Insured
If a landlord offers a rent-free period or a period of reduced rent as an incentive to new tenants, the sum insured declared to insurers for the purpose of calculating Loss of Rent must be the rent applying, after the end of the incentive period. Often the value of zero or the reduced sum is shown on the tenancy schedule and that figure is then used as the basis for calculating the sum insured in relation to Loss of Rent.
There’s a misconception that if a tenant invokes the rent suspension clause, the clock continues to tick down on the incentive period whilst the tenant is out of the building. In our experience most leases aren’t drafted in that way; when the tenant invokes the rent suspension clause, the clock stops on the rent-free period, and it only recommences when the building is suitable for occupancy. So, the Landlord has had to accept the reduced rent for an extended period.
A landlord offers a 6-month rent free period. The building is badly damaged by fire three months after the tenant has taken occupancy; the tenant invokes the rent suspension clause. The building takes 6 months to repair. When the tenant reoccupies the building, 9 months after the start of the original 6 month reduced rent period, they continue to benefit from a further 3 months of rent free (when they would have otherwise paid full rent). To be in the same financial position as they were in prior to the damage, the landlord will need the insurer to pay the rent that would otherwise have been received during these three months were it not for the damage.
VAT and Building Reinstatement Valuations (Commercial Property only)
Most Landlords can recover VAT on the cost of repairs to a building from HMRC. If VAT cannot be recovered, it must be added to the reinstatement cost that’s declared to insurers in order for the insurers to be expected to settle the VAT element of repair costs.
Historically, the language in property insurance policies gave the impression that values could be declared exclusive of VAT regardless of whether the Landlord could recover that VAT from HMRC. This lack of clarity came to an end when Pool Re, the government back UK terrorism insurance pool, changed its guidance to make it clear that claim settlements would no longer include a sum for VAT unless it had been explicitly added to the reinstatement valuation. Providers of Property Insurance quickly followed PoolRe’s lead.
VAT and rents declared to insurers
When an insurance claim is settled there has been no provision of a service so whilst VAT is often added to rent, you should not include VAT on rents declared to insurers.