New HMRC guidance clarifies domestic service charges

VAT and residential service charges

On 7 September 2018, HMRC published new guidance in relation to the above in the form of a Revenue and Customs Brief 6 VAT exemption for all domestic service charges, and Information Sheet 07/18 Applying the correct VAT liability on residential domestic service charges. HMRC also amended Section 12 Service charges and residential accommodation, of the Land and Property VAT Notice 742. This updated guidance has given rise to a number of issues for residential management companies.

Background

John Voyez of Smith & Williamson has been working for ARMA (Association of Residential Managing Agents) for nearly two years, liaising with HMRC to resolve a problem that had developed over time in the way management companies charge VAT to landlords. Errors in the appropriate accounting treatment by property management companies have arisen due to their application of an Extra Statutory Concession (“ESC 3.18”) which in fact is only available to property owners and landlords of residential property and not management companies. It is unfortunate that the ESC is not entirely clear in its wording and has led to a misunderstanding as to how it is to be applied. The position has not been helped in some cases where it would appear incorrect guidance has been given by HMRC to management companies. HMRC has now made it clear that the ESC cannot normally be applied by a property management company or similar, to supplies they may make to a landlord who needs to fulfil their obligations under a lease with the leaseholder or similar. It is only the freeholder or head lessee who may choose to use the concession.

When does VAT liability arise?

For VAT purposes all payments made by a leaseholder or similar under the terms of the lease with a landlord are further consideration for a supply made by the landlord of an interest in land and are exempt from VAT. This includes periodic payment such as service charges, estate charges and/or block charges which are usually collected by the property management company on behalf of the landlord. Thus, an obligation on a leasehold tenant to pay a service charge to maintain communal areas in respect of their residential lease means the service charge is VAT exempt. Furthermore, where such communal charges are raised by an owner of a residential state against freeholders living on that estate these can also be treated under the ESC as exempt by the owner of the state if the owner so wishes. This is to allow parity between leaseholders and freeholders living on the same estate.

However, any supplies made by a property management company will in such circumstances be to the landlord and not to the leaseholder even if the property management company collects payment direct from the leaseholder. The supplies of goods, services and staff in such instances will be a taxable supply to the landlord. The landlord in turn may recover such costs as the landlord incurs from the leaseholder by means of a service charge which is in effect further consideration for an exempt supply made by the landlord to the leaseholder or similar occupant. Note that there has been some debate with HMRC regarding the nature and range of different property interests that exist today, and who might be considered a “landlord”, and therefore able to use the ESC if they so chose. HMRC’s current view regarding Resident Management Companies (“RMC”) and Right To Manage Companies (“RTM”) is that although they may be a third party to the lease, it is normally the tenants’ obligation to pay the service charge, and this is an obligation that the tenant enters into with the landlord (not the RMC/RTM) in return for the grant of the lease by the landlord. Any failure by the tenant to make such payments due under the tenants’ lease will result ultimately in the forfeiture of the lease back to the landlord, not the RMC/RTM.

Which service charge recoverable staff are affected?

This means in relation to service charges and recoverable staff costs, there are three possible scenarios:

1. Where the landlord employs service charge recoverable staff, this is a cost to the landlord and that cost will be reflected in the landlord’s VAT exempt service charge to leaseholders
2. Where the management company employs service charge recoverable staff, this is a cost to the management company in providing services to the landlord, and the management company’s recovery of that cost is subject to VAT at the standard rate.
3. Where an RMC/RTM employs service charge recoverable staff, this is the same as for the management company, and recovery of these costs from the landlord is subject to VAT at the standard rate.

What will the cost be?

Therefore, when a management company invoices the landlord for the services provided, the invoice will include a taxable charge for all in house costs incurred. As above, the management company may employ a concierge in which case it would include the salary costs of the concierge, all external costs incurred, plus the management company’s own charges for the supply of services to the landlord. This invoice attracts VAT at the standard rate (currently 20%) on the full sum due and payable by the landlord albeit that the monies may be collected directly from the leaseholder. HMRC take the view that in the case of an RMC/RTM company employing the service charge recoverable staff, the VAT treatment is the same as stated at points 2 and 3 above. Indeed, the only time that there is an exempt supply of service charge recoverable staff is when the landlord/head lessor employs the staff themselves. In some cases management companies may treat third party costs incurred as disbursements, in which case the VAT on those costs incurred from third parties is not recovered by the management company, and the VAT inclusive invoice value is passed on to the landlord, or, as above, taken out of the service charges collected from tenants.

Summary

The important point to take from HMRC’s recent guidance is that it is only possible for the person who holds an interest in the property, an interest that the person is capable of granting to leaseholder or tenant, that is the person who can use the ESC if they choose. Property management companies, or similar, do not in normal circumstances hold a property interest that they can grant as owner and therefore they cannot use ESC 3.18, even if they have been empowered to collect payment direct from the leaseholder or tenant. As a result, their supplies to the landlord from 1st November must be treated as fully taxable irrespective of any previous direct or indirect advice that has been received either from HMRC or externally and which relates directly to the use of ESC 3.18. This is likely to result in a material increase in residential service charges for tenants.

Disclaimer

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

The tax treatment depends on the individual circumstances of each client and may be subject to change in future.

Smith & Williamson is an independently owned financial and professional services group. The firm is a leading provider of investment management, financial advisory and accountancy services to private clients, professional practices, entrepreneurs and mid-to-large corporates. The group’s c1,700 people operate from a network of twelve offices: London, Belfast, Birmingham, Bristol, Cheltenham, Dublin (City and Sandyford), Glasgow, Guildford, Jersey, Salisbury and Southampton.

Smith & Williamson LLP

Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

DISCLAIMER
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.