VAT and service charges: indivisible or not indivisible-is that the question?

This article gives consideration of the decision of the Upper Tribunal (Lands Chamber) in Janine Ingram v Church Commissioners for England [2015] UKUT 0495 (LC).

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Introduction

There appears to have been little comment on the recent decision of the Upper Tribunal (Lands Chamber) in Janine Ingram v Church Commissioners for England [2015] UKUT 0495 (LC), which is somewhat surprising given the importance of the issue of VAT on service charges.   I suspect that this may be a delay in public response while those most affected by the decision digest the impact and take advice, rather than a wholesale lack of concern about the decision.

The decision

The facts of the case are straightforward.  The Upper Tribunal was considering the appeal from the First Tier Tribunal in which the tenant challenged the element of service charges relating to VAT pursuant to s27A Landlord & Tenant Act 1985.  The lease permitted the lessor to employ such porters and staff together with such contractors agents or servants as the lessor considered reasonable.  The lessee was liable to pay such costs by way of service charge.  Managing agents were employed by the lessor to discharge its functions.  Payments were made by way of fees and salaries which included VAT.  The tenant argued that the VAT need not have been paid by the lessor to the managing agent and thus was not properly incurred for the purpose of s19 of the Landlord & Tenant Act 1985.

HHJ Alice Robinson dismissed the appeal by the tenant.  She held that the charges were not subject to the extra statutory concession concerning VAT on service charges because these were services provided by third party suppliers to management companies.  The judge considered that it was irrelevant that the landlord could recover the cost of the service as part of the mandatory service charge to tenants and that the charges were not mandatory service charges.  She considered that the concession did not apply to charges paid by the landlord or another person levying the service charge to third parties for the supply of services even though the costs of those services was passed on to the residential occupier through a service charge. 

Legal Framework

The general rule is that the letting of property is exempt from VAT pursuant to the VAT Act 1994, Schedule 9 and by Article 135 of the Council Directive 2006/112/EC (“the VAT Directive”).  Most property practitioners are aware that no such exemption exists with regard to service charges, and that the question of whether VAT is chargeable on service charges will depend upon whether they form a single supply with the provision of accommodation; they must be considered to be a single transaction when they are not independent see Case C-425/06 Part Service [2008] ECR I-897 at paragraph 51.  

The question of whether a transaction is a single supply is complex and requires consideration of the jurisprudence of the CJEU, which is frequently considered by the First Tier Tribunal (Tax Chamber) but which arises far less frequently in the Lands Chamber.  Detailed consideration of the substantial body of case law of the CJEU is beyond the scope of this article but, in summary, a single supply may be established by either a single, indivisible economic supply which it would be artificial to split as set out in Case C-41/04 Levob Verzekeringen and OV Bank [2005] ECR I-9433 at paragraph 22, or a principal supply in relation to which the other supplies are ancillary as considered in and CPP C-349/96): [1999] E.C.R. I-973; [1999] 2 C.M.L.R. 743 at paragraph 30.  These two methods of establishing a single supply are acknowledged in Field Fisher Waterhouse LLP v Revenue & Customs Commissioners ECJ C-392/11 [2013] S.T.C. 136 at paragraph 22 and The Commissioners for Her Majesty’s Revenue and Customs v The Honourable Society of Middle Temple [2013] UKUT 0250 (TCC) at paragraph 28.

In Field Fisher Waterhouse it was held that if the service charge was in the nature of rent (i.e. a charge directly related to the tenant’s right of occupation of the property) then the service charge is indivisible from the main supply of accommodation.  The CJEU gave important guidance and held:

 “28….The fact that the lease gives the landlord the right to terminate   it if the tenant fails to pay the service charges supports the view that there is a single supply, but does not necessarily constitute the decisive element for the purpose of assessing whether there is such a supply. On the other hand, the fact that services such as those at issue in the main proceedings could in principle be supplied by a third party does not allow the conclusion that they cannot, in the circumstances of the dispute in the main proceedings, constitute a single supply. It is for the referring court to determine whether, in the light of the interpretative guidance provided by the Court in this judgment and having regard to the particular circumstances of the case, the transactions in question are so closely linked to each other that they must be regarded as constituting a single supply of the leasing of immovable property.”

In The Honourable Society of Middle Temple v Her Majesty’s Revenue and Customs [2013] UKUT 250 (TCC) the Inn appealed against the decision by HMRC that the grant of a lease of land subject to an option to tax together with the provision of cold water, for which a separate charge was made, was a single supply.  The FTT allowed the appeal of Middle Temple but that decision that the lease and supply of cold water were separate supplies was quashed on the appeal of HMRC to the Upper Tribunal. 

HMRC has published the extra-statutory concession (“ESC”) which renders mandatory charges exempt from VAT.  This is provided by VAT Notice 48 para 3.18:

3.18 VAT: exemption for all domestic service charges

The concession exempts from 1 April 1994 all mandatory service charges or similar charges paid by the occupants of residential property towards the upkeep of the dwellings or block of flats in which they reside and towards the provision of a warden, caretakers, and people performing a similar function for those occupants. The concession does not exempt service charges paid in respect of holiday accommodation as defined in paragraph 1(e) of and Notes 11 13 to Group 1, Schedule 9, VAT Act 1994 (formerly paragraph 1(d) of and Notes (10) (10A) and (10B) to Group 1, Schedule 6, VAT Act 1983).

This ESC was referred to in HMRC press briefing Business Brief 3/94 which acknowledged that it aimed to address the anomaly that service charges paid by freehold owners or anyone receiving services which were not under the direction of the lessor or immediate landlord were taxable.  HMRC noted that the significance of the concession was “that the liability of the service charge will no longer depend upon the tenure of the residence or the status of the supplier.  What will be important is whether each resident is obliged to accept the service because it is supplied to the estate of buildings or blocks of flats as a whole.” 

Guidance on the ESC is given in VAT Notice 742.  The relevant provisions are as follows:

12.1 The basic position

Service charges relating to the upkeep of common areas of an estate of dwellings, or the common areas of a multi-occupied dwelling, are exempt from VAT so long as:

  • they are required to be paid by the leaseholder or tenant to the landlord under the terms of the lease or tenancy agreement

This is because the service charge is treated as ancillary to the main supply of exempt domestic accommodation.

12.4 What if a managing agent provides services to occupants on behalf of a landlord?

A managing agent acting on behalf of a landlord can treat the mandatory service charges to occupants as exempt, providing the agent invoices and collects the service charges directly from the occupants.

However, any management fee collected from the occupants is standard-rated because it relates to the managing agent’s supply to the landlord.

Analysis of the decision in Ingram

There are a number of concerns about the decision in this case, which may permit this decision to be challenged or distinguished in future cases.

Firstly, the Judge appears to proceed on the basis that ESC 3.18 only applies to the category of cases which were not covered by the principles in the primary legislation (i.e. those in which the service charges were not paid to a body or person which supplied the accommodation).   However, this does not appear to be consistent with the language of the ESC.  Although the underlying purpose was to redress the unfairness to the freeholder, no such limitation is contained in the wording of the concession and a level playing field would be achieved equally as well by the application of the ESC to all cases.

Secondly, it appears that the judge took the wrong approach to the nature of a supply as understood in the CJEU. This may be because relevant authorities were not cited.  Of course, a management fee is not exempt because the supply is to the landlord not to the tenant and so cannot be a single supply, as noted by HMRC in VAT Notice 742 paragraph 12.4 and so is not a supply “for those occupants”. However it could be argued that the provision of such services to the tenant by a third party could (depending upon the precise contractual and other arrangements) constitute a single supply together with the accommodation because the managing agent was precisely that, an agent, providing services to the tenant on behalf of the landlord.  Alternatively, such services would give rise to mandatory service charges within the meaning of ESC 3.18 in relation to the specified services provided to the occupants. 

Thirdly, it is unclear whether the appellant argued that the services were provided to the occupant. It appears unlikely because the judgment contains repeated references to the service being provided to the landlord.  The argument which was advanced appears to be the VAT was not reasonably incurred because an alternative option was available - see paragraphs 10, 19, 22 and 23.  Mr Reiss is recorded to have accepted that the salaries were no longer in the nature of rent, and relied upon the ESC, see para 23.  However, he may have been able to argue to the contrary namely that the service was still provided as part of a single supply because the managing agent was agent for the landlord and the supply was to the tenant not the landlord. 

Fourthly, the Judge considered the question of whether services were optional from the perspective of the absence of a contract between the lessee and the third party.  But, the relevance of optional services in the context of VAT is in relation to whether there is a single supply.  This is the context in which “mandatory service charges” are referred to by HMRC in ESC 3.18.  Equally at paragraph 42 the construction adopted by the Judge appears to render paragraph 12.4 of VAT Notice 742 incorrect, which is a draconian finding in the absence of representations from HMRC.

Fifthly, at paragraph 45 of the judgment the judge notes that an issue could arise in relation to s.19 Landlord & Tenant Act 1985, but no such argument had been raised in that case.  It is difficult to reconcile this with the earlier observation, at paragraph 10 that the issue was whether the VAT element of the fees were properly incurred, pursuant to s19 Landlord & Tenant Act 1985.  The Judge was sitting in the Lands Tribunal and not in the Upper Tribunal Chancery and Tax Chamber and so could only be considering the positon regarding service charges.  Her final comment acknowledges that an argument that service charges at the higher rate due to provision of services by third parties could give rise to charges which were unreasonably incurred and left this point open to be argued in further cases.

Finally, it is clear that this case was something of a David and Goliath situation but without the happy ending.  It is understood that the appellant was represented by his accountant[1] and acted against a highly respected silk.  This may explain why it does not appear that additional arguments and relevant authorities were advanced and relied upon by the appellant.  The main focus of Ingram is upon ESC 3.18, but an extra statutory concession is just that, a mere concession by HMRC which may be withdrawn and so may be of limited duration.  It does not appear that the appellant advanced arguments based upon the CPP or Case C-41/04 Levob Verzekeringen and OV Bank [2005] ECR I-9433, the analysis of single supply nor the pertinent decisions of Field Fisher Waterhouse and Middle Temple. The failure to advance all relevant arguments was unfortunate in circumstances where the case was being heard by a tribunal which was not an expert tax tribunal and compounded by the absence of HMRC who may have had some interest in intervening, given the criticism of the guidance they provided[2], but, who do not appear to have been given any such opportunity.  A key theme in the CJEU cases is the importance of the particular facts of a given case in determining whether there is a single supply.  Although the facts of the case are summarised in the judgment there is an absence of detail which makes it difficult to identify whether there would have been a single supply were further arguments advanced.

Conclusion

It appears unlikely that Ingram will be the final word on service charges and VAT.  The judge herself left open the question of whether the fees were properly incurred pursuant to s.19 Landlord & Tenant Act 1985 and so it appears probable that there will be further cases on this issue.  Further, it would be surprising if the matter were not considered in further detail by the Tax Chamber, or to be subject of further guidance from HMRC.

 

[1] The basis upon which the accountant gained rights of audience in the Upper Tribunal is not known.

[2] See paragraph 42 to 43 judgment.