Complex question of VAT on service charges

Benjamin Franklin wrote, “in this world nothing can be said to be certain, except death and taxes”. Yet it was only after certainty was provided by HM Revenue & Customs – in guidance confirming that the supply of property management and maintenance services to a landlord by a third-party agent was not connected with, or ancillary to, the supply of an exempt interest in a property and was therefore standard rated for VAT – that the dispute in Fairleigh and others v St George South London Ltd and others LON/00AY/LSC/2019/0338 and LON/00BJ/LSC/2019/0330 arose. The problem The applications concerned two mixed-use estates adjoining the south bank of the River Thames – Battersea Reach and St George Wharf. Under the arrangements in place for the maintenance of the estates, the landlords sought to discharge its management functions by engaging managing agents, who employed on-site staff at each estate. Under the provisions of the appellants’ leases, they were liable to contribute towards the costs incurred by the landlords in engaging managing agents to upkeep and maintain the estates. This included the VAT incurred on the costs of the managing agents employing on-site staff. The appellants, who were long leaseholders, argued that it was unreasonable for their landlords to refuse to arrange matters so that the on-site management and maintenance staff were employed directly by the landlords or jointly between them and the managing agents, rather than being employed solely by the managing agents. The consequence of the current arrangements was that VAT on staff costs was payable and the increasing costs of the same being demanded from the lessees through the service charge. The apparently simple issue the FTT had to determine was whether VAT on service charge costs – namely, in the supply of on-site staff by the managing agents – had been unreasonably incurred by the applicants’ landlords in discharge of their duties under the leases for the service charge years 2018 and 2019. This issue, however, raised complex jurisdictional questions in relation to section 27A. Jurisdiction Under section 27A(1), an application may be made to the FTT “for a determination whether a service charge is payable”. Under section 27A(3), an application can be made for a determination of the payability of service charge costs which it is intended will be incurred in the future. The FTT highlighted that, jurisdictionally, before it could decide an application under either section 27A(1) or section 27A(3), it had to be satisfied that the question before it engaged issues of payability under section 18, which related to the contractual or statutory legitimacy of the service charge cost. Relying on Williams and others v Aviva Investors Ground Rent GP Ltd and another [2023] UKSC 6; [2023] EGLR 18, the FTT reiterated that it could not make declarations solely about a landlord’s management decisions. The FTT also needed to be satisfied that sufficient information was provided by the applicant to assist it in making a determination about payability. If the above threshold was met, the FTT also determined that an applicant faced the burden of demonstrating they had a prima face case. In short, the lessees had to establish, at a minimum that (a) the focus of their challenge was not simply in relation to the manner in which their landlords reached their management decisions; and (b) that their challenge sufficiently formulated an alternative course of action that the landlord could adopt, which, if adopted, enabled the FTT to determine whether it was reasonably arguable that costs incurred would be saved. Ambivalence The FTT found that only one issue engaged the FTT’s jurisdiction; namely, the question of whether the landlords’ decision to procure the supply of on-site staff was or was not reasonable. This was an issue related to the outcome of the landlords’ decisions and not the manner in which those decisions were made. Even in reaching the above finding, the FTT was ambivalent about moving on to consider whether the lessees had made out a prima facie case. The FTT was concerned that the costs outcome was simply governed by fiscal law, as opposed to any complaint about the standard or provision of services, which the FTT found to be “high-quality” and “value for money”. To meet the threshold requirement, the lessees would have to satisfy the tribunal that the new arrangements they proposed were (a) realistically capable of being implemented; (b) more likely than not to achieve the tax saving that would accrue for their benefit; and (c) preferable to the status quo, taking into account all other material non-tax factors. The proposed arrangements Evidentially, the FTT found that the lessees’ proposed alternative arrangement – direct employment of staff by the landlords or joint employment of staff between the landlords and the managing agents – did not achieve the economies of scale suggested. Further, there was a risk that such proposed arrangements would attract adverse scrutiny from HMRC. The lessees failed to make out a prima facie case. Key point The FTT can only determine an application under section 27A(1) and 27A(3) of the Landlord and Tenant Act 1985 if the question before it engages issues of payability under section 18 and meets the “prima facie” threshold test Elizabeth Dwomoh is a barrister at Lamb Chambers Photo © Christopher Bill/Unsplash