Recent VAT tribunal decisions have led to uncertainty as to how serviced apartment operators should treat their income. Adam Cutler from accountancy firm Crowe provides background to the issue and what operators should do to protect their position while litigation is ongoing.
The traditional approach to VAT
If people have heard of one VAT case, it is normally the one which examined whether a Jaffa Cake was a cake or a biscuit. This demonstrates the difficulties where you have something that is part way between two items that have different VAT treatments.
Until recently, VAT questions around the treatment of serviced apartments focused on a similar challenge. A suite in a hotel is subject to VAT; however, the rent of a furnished flat is exempt. Where do you draw the line, and which side of it does a serviced apartment sit?
A common answer would be 90 days, based on a definition of ‘short’ in planning regulations – HMRC are generally comfortable with this. However, another factor should be how many additional services are provided – the closer a serviced apartment is to a hotel room, the more likely it is to be taxable regardless of the length of stay.
Is exempt necessarily better?
If you are letting a serviced apartment to a party that cannot recover VAT, such as a private individual for a few weeks’ holiday, it is clearly preferable that no VAT is charged.
However, longer term rents are more likely to be for corporate customers. Of course, not all companies can recover VAT in full and some overseas companies which could recover VAT in principle may decide the costs of making a reclaim are not justified in practice.
Where an operator is letting to a customer who can recover VAT, it would be preferable to charge VAT. If the operator’s income is exempt, they cannot recover VAT on their costs, and would have to pass on these gross costs to their customers. That said, the biggest cost of the operator – acquiring the flat itself – should not be subject to VAT.
Taking a very simple example: supposing an operator can charge £1,000 per week for a serviced apartment. They could incur £300 plus £60 of VAT per week of operating costs such as laundry and cleaning, and £500 per week to rent the flat.
Scenario A shows the position if this is a long tenancy and the rent is exempt. Scenario B shows the position if 20 per cent VAT is be paid to HMRC out of the £1,000 rent. However, Scenario C shows the customer recovering VAT, so they should be willing to pay VAT on top of the £1,000.
| Scenario | A | B | C | D |
| Income (net of VAT) | £1,000 | £833 | £1,000 | £962 |
| Operating costs (net of recoverable VAT) | £360 | £300 | £300 | £300 |
| Rent (exempt) | £500 | £500 | £500 | £500 |
| Profit | £140 | £33 | £200 | £162 |
Even if a customer cannot recover VAT in full, taxable treatment for long-term lets can be preferable. If a customer stays for more than four weeks, from day 29 a reduced value rule applies which normally means the VAT rate chargeable effectively drops to four per cent. The operator is still able to recover all of the VAT on its costs, so this may be a better option. As shown in Scenario D, above, the difference between the two potential VAT treatments for long-term rents may be finely balanced.
What has changed?
Firstly, Airbnb and similar suppliers offer a different VAT model for short-term letting that poses a significant challenge to serviced apartment operators. These companies would argue that they provide a service of introducing an individual owning a flat and a holidaymaker looking for somewhere to stay. The fee for this service is subject to VAT.
However, the flat is let by the owner as principal. If the owner’s income from this is less than £85,000 per annum, they will be below the registration threshold and not have to charge VAT.
HMRC has successfully challenged this operating model in other areas, notably winning the argument that Uber was an employer providing a taxi service, rather than just connecting self-employed taxi drivers with potential customers. At present, this argument has not been successfully deployed by HMRC to holiday lets.
The tour operator argument
More recently, another argument has been deployed as to why VAT should not be due at 20 per cent on the full amount paid for a serviced apartment let.
The UK has retained an EU simplification known as the Tour Operators Margin Scheme (TOMS). TOMS exists to avoid package tour operators having to register for VAT and prepare VAT returns in several countries to deal with the various costs incurred. It is a complex calculation, but in essence they do not recover any VAT on their costs or add it to the price charged. Instead, they pay over VAT on the gross margin.
As a result, if your customer is unable to recover VAT, and most of your costs do not have VAT on them, it is more favourable for your activities to fall under TOMS. Serviced apartment operators providing short term lets to holidaymakers are likely to fall under this category.
| Scenario | TOMS |
| Income | £1,000 |
| Operating costs | £360 |
| Rent | £500 |
| Margin | £140 |
| VAT due on margin | £23 |
| Profit | £117 |
Sonder, a serviced apartment operator in this market, successfully argued last year at the First-tier Tribunal that its serviced apartment lets fall under TOMS. A similar argument was won a few weeks ago by Bolt in respect of its taxi service. This followed previous court rulings that TOMS does not only apply to package holidays, but can also apply to a single service. The service must be one that is typically provided to holidaymakers and is bought in and supplied on without material alteration – the tribunal held these tests applied in both cases.
What next?
Unsurprisingly, HMRC has appealed both decisions, and they are expected to be considered by the Upper Tribunal later this year. Given the amounts at stake across several sectors, this litigation could continue through to the Court of Appeal and Supreme Court.
What should service apartment operators do in the meantime?
If you are a serviced apartment operator letting to holidaymakers, in a similar position to Sonder, you may have overpaid VAT.
Overpaid VAT can be adjusted for the last four years. Given that this litigation may take several years to resolve, if you feel your position is like Sonder then I would recommend looking at making a claim now to protect your position. If the cases drag on for several years, further claims may be necessary to cover later periods. Waiting until the litigation is resolved is likely to mean periods have fallen out of time to reclaim overpaid VAT.
First-tier Tribunal decisions do not bind HMRC in respect of other taxpayers, so HMRC may refuse claims from operators with a similar model.
Even if Sonder is successful at the Upper Tribunal, HMRC may seek to differentiate their position from other operators. In particular, the First-tier Tribunal considered there had not been a material difference between the flat rented by Sonder, and what Sonder provided to the customer. The closer an operator’s customer offer is to a suite in a hotel, the more difficult this argument will be to run.
Other operators may well want to differentiate themselves from the Sonder position and apply the long-established VAT treatments. As shown in my example, the TOMS approach results in a higher profit compared to Scenario B, but for long-term stays and corporate customers, this traditional approach is likely to yield a better result.
This uncertainty is unlikely to be resolved for several years. In the meantime, I recommend all serviced apartment operators compare their operating model with that of Sonder. The next steps may then be to make a protective claim for VAT potentially overcharged, or take steps to differentiate themselves from Sonder, depending on their market.
