On 5 July 2023, the First-tier Tribunal released its decision in the case of Sonder Europe Ltd (TC8852). The judge found against HMRC and allowed the taxpayer to account for VAT on the margin only, rather than on the full sales price as HMRC had contended – a result which will be of particular interest to businesses purchasing property which they rent to travellers.
The rental of qualifying residential property is generally exempt. However, positive rates of VAT apply in industries such as tour operators and the hotel sector. Both these industries are wider than might be expected, including anyone outside those industries who make supplies of a similar description.
In the tour operator industry, for example, the rental of property to travellers is subject to VAT at the standard rate, but only with respect to the margin between the supplier’s costs and their sale prices. HMRC refers to this as the tour operators’ margin scheme (TOMS).
How TOMS works
TOMS can be beneficial for some businesses, reducing the amount of VAT payable to HMRC. These businesses typically do not pay VAT on at least some of its purchases (eg residential property leased from landlords is exempt) and a large portion of their customers cannot recover VAT (eg private travellers).
The TOMS calculations are complex, but are founded on the Value Added Tax (Tour Operators) Order 1987. The definitions in this legislation are broadly drawn, applying to anyone making purchases ‘for the purposes of his business’ and making supplies ‘for the benefit of a traveller without material alteration or further processing’. The services included are ‘of any kind commonly provided by tour operators or travel agents’, which will include the provision of sleeping accommodation among many other kinds of supply.
Until now, HMRC has regularly excluded suppliers from using TOMS on the grounds that they cause ‘material alteration or further processing’ to the goods or services purchased. HMRC is not explicit as to what it includes in ‘material alteration or further processing’, but regularly refers to qualities such as maintenance work, furnishing, making short lets from long leases, and so on.
A recent judgment has changed that position, broadening the application of TOMS. It is important that TOMS is not optional: anyone making qualifying supplies will be required to apply the TOMS calculation, whether they find it advantageous, disadvantageous, or invariant but an additional administrative awkwardness.
- TOMS can be beneficial for some businesses, reducing the amount of VAT payable to HMRC.
- HMRC has regularly excluded suppliers from using TOMS on the grounds that they cause ‘material alteration’ to the goods or services purchased.
- The tribunal found the change from leasing in the apartments for a term of years to letting them out as short-stay holiday accommodation did not amount to material alteration.
- Businesses that lease property which they offer as holiday accommodation should consider whether they have overpaid VAT in the past.
The taxpayer had leased UK property from landlords. It had furnished it where required and undertaken a responsibility to repair damage caused during its lease. The taxpayer then rented furnished properties to travellers. The taxpayer did not consider itself to be a travel agent, styling itself only as hospitality, but it did consider that it made supplies under TOMS and accounted for VAT on its margin only, significantly
reducing the VAT paid to HMRC.
HMRC rejected the taxpayer’s arguments and required payment of VAT on the full sales price. HMRC’s case was that leasing exempt residential accommodation for a long term (measured in years) and then sub-letting the property to travellers for a short term (measured in days) does not fall within the TOMS. HMRC’s argument had two tracks.
- the purchase on a long-term lease of residential accommodation by the taxpayer meant that it had used its own ‘in house’ resources to make short-term supplies of travel accommodation; or
- the onward supply was materially altered or processed, within the terms of the Value Added Tax (Tour Operators) Order 1987, when the supply changed from an exempt purchase of property to a taxable supply of accommodation to travellers.
The tribunal rejected both of HMRC’s arguments. In dismissing quickly the first argument, the judge found no requirement in the legislation that the bought-in supplies must be identical to the supplies provided by the taxpayer to the traveller. The taxpayer had still made onward supplies of the apartments for the purposes of the TOMS. The change from leasing in the apartments for a term of years to letting them out as short-stay holiday accommodation did not amount to material alteration or further processing.
The tribunal made several useful comments in its reasoning. It considered the correct test to be whether the apartments themselves, and not the tax status of their supplies, were materially altered or further processed before they were supplied by the tour operator to the travellers. In reaching this reading of the UK legislation, the tribunal was mindful that the law was to be construed consistently with the EU VAT legislation which underlies the current UK VAT legislation and which contained no reference to ‘material alteration or further processing’.
The judgment was that the taxpayer - despite being a hospitality provider - qualified as a tour operator in supplying holiday accommodation to travellers. Its supplies qualified for TOMS because the bought-in property was used to supply holiday accommodation to its customers without significant alterations or further processing, despite the addition of furnishing and damage repairs and despite the change in the length of the letting. The VAT liability was therefore correctly calculated on the margin by the taxpayer, and not on the full sales price as HMRC had attempted to impose.
It is not surprising to see the judge describe HMRC’s position as ‘absurd and impractical’, given how awkward the scheme is.
HMRC has consistently applied a flawed approach to exclude taxpayers from TOMS, resulting is excessive VAT amounts being paid to HMRC.
Taxpayers who lease property from landlords and supply it to travellers should be considering whether they are accounting for VAT on the full selling price in accordance with HMRC guidance and whether their VAT bill should be significantly lower. Such businesses should consider adjusting their VAT calculations for the future and submitting claims to HMRC in respect of the past, seeking to recover any VAT overpaid. A cap of four years prevents the amendments of earlier errors and it is therefore important that claims be submitted early to HMRC in order to prevent earlier VAT from being recovered.
Further questions will emerge if HMRC does not appeal this decision. For example, how would the specific rules for transfer of going concern purchases and capital goods schemes interact with TOMS? And will TOMS apply to businesses that currently benefit from being able to charge VAT on their full sales prices, eg if their customers are able to recover VAT? Businesses should be considering implications with their advisers and preparing accordingly.
TOMS is a notoriously difficult area and it is not surprising to see the judge describe HMRC’s position as ‘absurd and impractical’, given how awkward the scheme is.
Once all these changes, considerations and claims have been processed, perhaps we shall each need to check into holiday accommodation!
First published by Taxation.