HMRC has changed its guidance on whether VAT which should be charged for management services provided for freehold dwellings.
One of the most confusing issues relating to property is the VAT liability of the care, maintenance and repair of ‘common’ areas of residential property.
For a block of flats, this service would typically include looking after the elevators, corridors and doors (both internal and external). For a house on an estate with communal gardens or other facilities for the use of the residents, the owner of that house (whether freehold or leasehold) may be required to pay a service charge towards the cost of maintaining those communal areas.
HMRC has always accepted that the provision of such services to tenants or leaseholders (ie not the owner of freehold properties) by the landlord are exempt from VAT because the services are part of the supply of the right to occupy the residential property, which is also exempt from VAT. Such management charges are usually set out in the lease and form part of the underlying supply of the property.
In 1994, HMRC extended this exemption to services provided to freeholders paying service charges provided by owners of shared residential estates. This was, and remains, expressed as a concession: ESC 3.18 (VAT Notice 748, Extra-statutory concessions).
The VAT treatment of such services not only determines whether VAT is charged to the freehold owners of the dwellings, but also whether the freeholder of the common areas (which may be a trust or company) can claim VAT on related costs.
Under normal VAT rules, businesses can’t claim VAT on the cost of goods and/or services used to make exempt supplies. When following ESC 3.18, the freeholder owner of the common areas can't claim VAT on related costs, including VAT charged by third-party service companies that actually carry out the maintenance and upkeep of the property concerned.
Since ESC 3.18 was introduced, there has been some confusion in the sector about how it should apply to services provided by third-party service companies, ie not directly by the owner of the common areas.
The contracts are carried out in various ways and in many cases, the freehold owners of the dwellings have no direct contact with the owner of the whole estate. Usually, the estate owner appoints a service company or other third party to carry out the services or employs a warden or caretaker to do the day-to-day work. It may also buy goods and materials to carry out the duties under the contract eg materials for repairing damaged property, plants and equipment on behalf of the freeholder.
The management company issues invoices for the service charges and collects payment directly from the freehold owners of residential properties. However, as the contract is between the owner of the entire estate and the service company, the services supplied are liable to VAT at 20%. Some management service companies get this wrong as they treat these service charges as VAT exempt (a fairly common VAT accounting mistake).
The issue was considered by the upper tribunal in 2015 in a case which confirmed that the exemption applies only to services supplied by the estate owner freeholder to the residential property owners. It does not apply to services supplied by management companies or other suppliers, even if they collect payment and deal directly with the residential property owners on behalf of the freeholder.
'Unclear' guidance revised
The tribunal commented that one reason for the confusion was that HMRC's guidance on the subject as set out in VAT Notice 742: Land and property, section 12.2 was somewhat unclear.
HMRC has now revised the guidance to confirm the correct position. It has also issued Revenue and Customs Brief 6 (2018) and VAT Information Sheet 07/18 which explain that the correct concessionary rules must be applied from 1 November 2018.
This is an important issue for property management companies as they must ensure they correctly apply ESC 3.19 from 1 November 2018.
From a technical perspective, it is interesting that HMRC appears to have taken note of the comments made by the tribunal and issued the guidance discussed above to clarify the issue. This doesn't happen often!