Following the recent ECJ case of Field Fisher Waterhouse (FFW) it looks likely that the VAT treatment of service charges paid under most leases will continue to depend upon whether the landlord has opted to tax the property. If a landlord has not opted to tax the property but wants to charge VAT on the service charge it should consider using a separate management company to supply the services.
The landlord in FFW had not opted to tax the property so the occupational rent was VAT exempt. The service charge was also reserved as rent. The traditional view is that in those circumstances the landlord makes one bundled supply with the VAT treatment depending upon whether it has opted to tax the property. On this basis the landlord in FFW treated the service charge as VAT exempt.
However, in an attempt to reclaim some extra VAT from HMRC FFW as tenant argued that the letting of the property and the services covered by the service charge were actually two separate supplies with the services being VATable regardless of whether the rent was.
What did the ECJ say?
Was it one VAT exempt supply or two supplies, one VATable (the services) and one exempt (the property)? The ECJ would only provide guidance on the law rather than a definitive answer to the question, (which the UK courts will have to answer based upon that guidance). However, the judgment strongly suggests that the ECJ thought there was only one supply of the property. What it said was:
- in principle the services supplied under a lease can be part of a single supply of the property;
- obtaining the services did not appear to constitute an end in itself for FFW and for the average tenant like FFW such services are instead a means of enjoying the premises – the services would have been no use to FFW without the property;
- including the services in the lease (with a right for the landlord to forfeit if the tenant fails to pay the service charge) supports the view that there is a single supply but is not decisive - including services in a lease that have nothing to do with the property will not make them part of the supply of the property; and
- the fact that the services could have been provided by a third party did not prevent there being one supply by the landlord.
In light of this guidance our view is that the UK courts are likely to decide that there was one exempt supply of the premises to FFW.
What does it mean for my lease?
Although we need to wait for the decision of the UK court, this case strengthens the view that the VAT treatment of service charge reserved as rent follows the VAT treatment of the property and the occupational rent. If the landlord has opted to tax then the service charge should be VATable. If the landlord has not opted and the property is VAT exempt then the service charge should also be VAT exempt.
If you are letting a VAT exempt property but want to charge VAT on the service charge then you should use a separate management company to provide the services and invoice the service charge separately. This would allow you to recover some of the VAT on your costs (if all of your supplies to the tenant are VAT exempt your own VAT recovery will be restricted).