With the upcoming changes in tax relief, many private landlords are transferring their portfolios into property companies.
Rent charged by landlords to tenants of residential property is usually exempt from VAT. This exemption also applies to mandatory service charges applied by landlords (to cover the upkeep of buildings and gardens) because the service charge follows the liability of the rent i.e. it is related to ‘land’.
Also in recent years, many owners of apartments and flats have formed management companies, to hold the freehold title, which then levies a similar service charge on the individual leaseholders.
The VAT position
So far so simple, but what is the VAT position if the service charges are levied by a third party? That third party could be a management company in which the leaseholders own a share, or a managing agent that has the authority to collect service charges on behalf of the landlord. In such cases, the exemption still applies because of Extra-Statutory Concessions in VAT Notice 48, para 3.18. The aim of ESCs is to correct anomalies where a strict application of the law would produce an unfair outcome to some taxpayers.
Tax Tribunal decision ‘throws a spanner in the works’
In a recent tribunal case, Janine Ingram v CCE the upper tribunal confirmed that services provided by third party suppliers to landlords or management companies (in relation to residential property) must charge VAT at 20%. This applies even if the landlord is able to recover the cost of the service as part of a mandatory service charge to tenants and leaseholders.
Janine Ingram challenged the VAT charge made to CCE by the managing agent Knight Frank LLP (KF) in relation to the cost of porters which KF employed under a PAYE arrangement. CCE then recovered the VAT inclusive cost of the payments made to KF as part of the mandatory service charge issued to individual leaseholders such as Ms Ingram.
The upper tribunal confirmed that service charges made by landlords to residential tenants were exempt from VAT as long as “they directly related to the tenant’s right of occupation”. The exemption also applied to third parties collecting service charges (i.e. not the landlord) because of the ESC. But the ESC could not apply to “optional services” supplied by a landlord and most importantly (the crux of the case), VAT exemption does not apply to any services provided by third parties (like cleaners or builders) to the landlord or other person levying the service charge, even if the cost of those services will be passed to leaseholders through a mandatory service charge.
The outcome of the case gives certainty to traders providing building, cleaning or maintenance services to landlords because the administrative challenge of deciding whether a service was being directly passed onto a leaseholder as part of a compulsory service charge would have been a nightmare.
How to avoid the ‘VAT trap’
- If a managing agent employs for example a maintenance worker or a caretaker and recharges the salary and costs to the landlord or management company collecting service charges, then this recharge will add 20% VAT as a standard rated service (assuming the agent is VAT registered). The landlord cannot claim input tax so will pass on the VAT inclusive cost to the tenants or leaseholders.
- But if the landlord (or third party collecting service charges) employs staff directly, then the irrecoverable VAT element is eliminated. So by restructuring employment arrangements, the VAT element disappears, thus reducing service charges for many leaseholders and tenants.
If any of you would like more detailed information on any aspect of VAT & Property, send me an e-mail and I’ll be pleased to advise further.