In its true meaning, a compensation is not a payment for a supply of goods or services, therefore VAT does not apply. The commercial reality is often different than the labels attached to payments, and the VAT position changes accordingly.
The guidance below is a basic view of how certain payments are generally treated.
Payments generally treated as compensation: outside of scope
compensation by tenant for landlord’s legal fees to extend the lease – tenant exercises the right to extend already granted in the lease
statutory compensation (under the Landlord and Tenant Act, or Agricultural Tenancies Act) on termination of a lease
dilapidation payments by tenant to the extent they genuinely reflect failure to observe covenants to maintain the property. This treatment is likely to apply only once lease expires and tenant is technically in breach of the repair covenant
mesne profits awarded against tenant who fails to vacate property – usually in a court order for possession of property against the tenant
penalty charges in a car park is seen as payments for a breach of contract or trespass and hence outside of scope
compensation awarded by the court or agreed in an out of court settlement.
Payments for supply: subject to VAT
compensation by tenant for landlord’s legal fees to extend the lease – tenant did not have a right to extend already granted in the original lease, and so acquires a new right that the landlord may grant or refuse
payment under a Tomlin order – treated as consideration for the surrender of the lease
dilapidation payments incurred before lease expires
overpayments by customers who do not have the correct change are additional consideration for the use of car parking facilities and subject to VAT
compensation by tenant to dispose of an onerous lease is treated as a supply by landlord to tenant under the lease and subject to VAT
tenant agrees to take the obligation of the vendor in carrying out land decontamination is treated as a supply by tenant and is subject to VAT. In most cases an obligation to decontaminate is acquired with the land and will result in a discount offered to the buyer, rather than result in an actual payment
compensation awarded by the court or agreed in an out of court settlement, where this is in relation to a dispute over an earlier supply
receipt of non-refundable deposit to secure a hotel or holiday accommodation.