VAT And Service Charges

A current European case is examining whether the provision of services by a landlord to tenants is a VAT-able supply even if the landlord does not charge VAT on the rent.

Before entering into a new lease of commercial premises, the prospective tenant will always want to know, and his lawyers will enquire as part of the pre-contract due diligence process, whether the landlord has "opted to tax" the property – namely, whether it has elected to charge VAT on the rents payable under the lease it is proposing to grant. This includes not only the "principal" rent, but also any other sums which are reserved as "rent" in the lease and this will usually include the sum that has to be paid to the landlord as service charge.

"The Court of Justice of the European Union are now considering the point again and will be making a ruling in due course. This could have implications for tenants and in particular those who have issues over VAT recovery."

Of particular interest to tenants and their advisors in this regard is the new RICS published "Service Charges in Commercial Property Code of Practice (second edition)" which has been in effect since 1 October 2011. While this covers many matters pertaining to service charges, it also discusses the issue of VAT on service charge. Principally, it aims to promote transparency so that tenants know the full position and the extent of their payment obligations before entering into a lease.

VAT election

A landlord may decide to elect (known as "opting" to tax), because he wishes to be able to recover VAT on expenditure related to the property. If the landlord does not so elect, the lease and the rents are exempt from VAT. Most leases of commercial premises include a service charge which allows the landlord to recover from the tenant the cost of services that it supplies. These services range from basic provision of utilities, lighting and heating, maintenance of common parts and so forth to more sophisticated security systems and supplying staff.

The basic view of HM Revenue & Customs is that where a landlord has an obligation to provide services in the building, the cost of which is then charged to the tenants, the charge for those services goes hand in hand with the rent that is charged and accordingly whether there is VAT on the service charge depends upon whether there is VAT on the main rent. Therefore, service charge will be treated for VAT purposes in exactly the same way as the basic covenant to pay rent. If...