VAT – Lease service charge provisions
VAT advice was sought on the effect for a tenant of the service charge provisions in a lease of a commercial unit in a building which consisted of two commercial units and eight flats, all owned by the same lessor. Each lease also carried the right to use a designated car park space.
HMRC’s practice was that a service charge assumed the same VAT liability as the premium or rent payable under the lease provided that it was a common service charge which related to the external fabric or the common parts of the building, (as opposed to the demised areas) and was paid for by all the occupants. The service charge here fell within this description and, as the landlord had opted to tax the building would, in relation to the leaseholders of non-residential premises, be treated as the consideration for a taxable supply, giving rise to an obligation on the landlord to account for VAT and issue a valid VAT invoice to the tenant. In relation to residential leaseholders the service charge remained exempt.
Doubt had been cast on HMRC’s practice by the decision of the European Court in RLRE Tellmer Property sro v Financní reditelství v Ústí nad Labem although HMRC were sticking to their guns on this one (see Revenue & Customs Brief 67/09). Questions were been referred to the European Court on the application of Tellmer in Field Fisher Waterhouse LLP v HMRC and Purple Parking Ltd and Another v HMRC. The upshot might be that HMRC’s practice of the service charge liability always following that of the rent where they are paid to the same person is discredited. In that case, some or all of the service charge paid by the residential lessees could be taxable at the standard rate and this would make a difference to the input tax recovery percentage for the lessor and therefore the amount charged on to the leaseholders in respect of irrecoverable VAT incurred by him.
There was no obligation in the lease to issue a VAT invoice in respect of either the rent or the service charge with the consequence that, although the VAT Regulations 1995 provide that a VAT invoice must be issued within 30 days of the time when the supply is treated as taking place (the ‘tax point’), the tenant had no legal right to demand one.
Section 6(3) VATA 1994 sets out the basic rule determining the tax point for a supply of services which is that the time the services are performed. Regulation 90 Value Added Tax General Regulations 1995 modifies these tax point rules for supplies of services the consideration for which is payable ‘periodically or from time to time’. In such a case the supply is treated as made at the earlier of the time payment is received by the supplier and the issue of a VAT invoice. This meant that in the case of the service charge there would only be a tax point if, and to the extent that, payment had been made or a valid VAT invoice issued.
Input tax recovery by tenant
Input tax is to be claimed on the VAT return for the period in which the VAT became chargeable, that is, the period covering the supplier’s tax point however, a taxable person cannot make a claim unless he holds the evidence required to substantiate that claim (a valid tax invoice) or alternative evidence of the taxable supply which is acceptable to HMRC. Input tax cannot be claimed more than four years after the date by which the return for the first period in which input tax could be claimed is required to be made.
Amount of service charge
Clause 5.6 of the lease stated that:
‘Any sums payable hereunder by the Tenant shall be deemed to be exclusive of Value Added Tax and the amount of any such tax payable thereon (whether by the lessor or by the Tenant) shall be paid by the Tenant.’
Part I of the Sixth Schedule which set out the obligations of the lessor to provide the services in respect of which the service charge for the commercial unit was payable had the following rather oddly tacked on at the end of the list of services, with no operative provision:
The payment of Value Added Tax at the rate for time to time in force (not being Value Added Tax recoverable by the lessor) on the cost of any of the services provided or paid for by the lessor.’
Most of the services listed in Part I of Schedule 6 were, in principle, subject to VAT, other than insurance, rates and the services of employees. To the extent that the services were not subject to VAT when supplied to the lessor there would be no irrecoverable VAT to be passed on to the tenant.
The letting of car-parking is, in principle, subject to VAT at the standard rate (irrespective of whether the option to tax applies) however the European Court in Skatteministeriet v Henriksen decided that exemption applied to lettings of premises and sites for parking ‘closely linked to’ exempt lettings of immovable property. This meant that the car parking supplied to leaseholders of the residential units was also exempt.
Where a business is not fully taxable it cannot recover all its input tax (subject to the de minimis limit which was not relevant here). It the becomes necessary to determine how much of the input tax can be reclaimed. This must be done by applying the partial exemption rules.
How should any irrecoverable VAT be charged on under the lease?
The provisions of the lease were not at all clear in this respect. Paragraph 12 of Schedule 6 provided that the tenant would pay VAT ‘(not being VAT recoverable by the lessor) on the cost of any of the services provided or paid for by the lessor’.
To the extent that taxable services were supplied to the landlord and were subsumed in the taxable service charge all the VAT on that part of the cost was recoverable. In relation to the charge made in respect of the residential units none of the VAT cost would be recoverable therefore, assuming that the same provision was included in the residential leases, arguably, the service charge payable by the residential tenants should include the whole of that irrecoverable VAT.
The result of this would be that commercial units would not have been charged VAT on VAT (which would have amounted to an indirect subsidy for the residential units). The residential units would be in the same position as if there were no commercial premises in the building.
1. The service charge in relation to the commercial unit and car-park space was subject to VAT at the standard rate.
2. The service charge in relation to the residential units may be taxable depending on the outcome of the references to the European Court in Field Fisher Waterhouse and Purple Parking. Adjustments going back four years would then be necessary (subject to the terms of the residential leases). Any such adjustment would affect the lessor’s partial exemption recovery percentage for the relevant periods.
3. A supply would be made for VAT purposes on the earlier of the date of payment and the date of issue of a VAT invoice in respect of the service charge.
4. If not already issued to give rise to a tax point, a valid VAT invoice must be issued in respect of the taxable supplies under the lease within 30 days of the tax point although a tenant had no legal right to call for one.
5. Although the lease was by no means clear, the better view was that the service charge for the commercial units should not include any irrecoverable VAT charged to the landlord as that was attributable only to the residential units.
6. If the construction in 5. above was wrong, only the appropriate percentage of any irrecoverable input tax resulting from the application of a partial exemption special method could properly be included in the service charge for the commercial units. There were no grounds for attributing 100% of the irrecoverable VAT to the commercial units (as the lessor had in fact done). The lessor could be made to go back for up to twelve years (the limitation period for claims under a lease) and do a proper partial exemption calculation in order to establish the correct amount of the service charge (even though he could only recover four year’s worth of additional input tax himself).
7. Subject to holding the necessary evidence, a taxable tenant could recover the input tax on the service charge by including it in the return for the VAT period in which the tax point fell. There was a time limit of four years for adjusting earlier VAT returns but this would only be relevant if the tax point was in earlier VAT periods.
Update (at October 2012)
In February 2012 the European Court decided against the taxpayer in Purple Parking. At paragraph 27 of the judgement the Court cited Tellmer as authority for the proposition that ‘in certain circumstances, several distinct services, which could be supplied separately and thus give rise, separately to taxation or exemption, must be considered to be a single transaction where they are not independent.’
The European Court released its judgement in the Field Fisher Waterhouse reference on 27th September 2012. The Court has referred the matter back to the High Court but has provided guidance on how to interpret the EU provisions and given a strong indication that there is a single supply in these circumstances so expect Field Fisher Waterhouse to be unsuccessful.
At the time of publication this case study was technically accurate however, as tax law and practice change rapidly, you should take specific advice before taking any action.