Must a landlord take steps to avoid VAT on staff costs recharged via a residential service charge?

Battersea Reach

Various Lessees of Battersea Reach and St George Wharf v St George South London Ltd & Ors [2023]

In a recent decision of the First-tier Tribunal (Property Chamber), the Tribunal confirmed that the various landlords of blocks at two substantial residential developments were not to be taken to have unreasonably incurred the VAT element of the cost of site staff by reason of the fact that, had they employed those staff directly rather than procured them via the managing agent, no VAT would have been incurred.

Whilst the issue can be shortly expressed, the underlying issues of fact and law were complex, engaging VAT, employment and property law issues. Following HMRC clarification in September 2018 that managing agents employing site staff directly should be recharging the cost of those staff to their landlord clients with VAT added, staff costs in many residential developments have increased by 20%.

The developments in question in this case contain around 2,500 residential units, with circa 35 staff employed on each site. The total VAT on the staff costs amounts to around £500,000 per year, which was an additional cost to the service charge from November 2018 onwards – prompting a group of lessees from each development to take these proceedings, arguing that the landlords should each take the site staff on as direct employees so as to (they argued) not attract VAT on those costs.

Having heard a large volume of evidence, including from 7 expert witnesses covering property management and taxation issues, the Tribunal found against the lessees, finding:

  • The Tribunal does not regulate the process by which a landlord reaches its decisions. Criticism of the process by which the landlords had reached their decisions on how to proceed with employing staff (with the benefit of hindsight) did not engage the Tribunal’s jurisdiction under s27A Landlord and Tenant Act 1985: §54
  • It was questionable whether even the challenge to the landlords’ decision to procure the supply of site staff from the managing agent rather than employ directly properly engaged the jurisdiction, as the costs outcome (i.e. that VAT would be added to the cost at 20%) was simply governed by fiscal law; there was no complaint about the standard or provision of the services: §54.
  • The alternative models for the provision of site staff (which were argued to avoid incurrence of VAT) put forward by the lessees were not realistically capable of being implemented on the facts of the case. There were far too many potential obstacles. That being so, it could not be said that it was unreasonable for the landlords to adopt the stance that they did (i.e. maintaining the status quo whereby the agent employed the staff who provided services across all the landlords’ blocks and common parts of the developments): §62
  • It was obvious that there were many complexities to implementing an alternative model, with a real risk of future litigation resulting from any change in arrangements, including on property, taxation and employment law grounds. Those were not risks that it would be unreasonable for a landlord to seek to avoid: §71, 74, 98.
  • In tax terms, there was a series of ‘ineradicable risks’ associated with the suggested changes in arrangements, including a real risk of HMRC interest in the arrangements as an impermissible species of tax avoidance and/or abuse of rights, a risk of HMRC challenge to the arrangements, and the fact that the outcome of such a challenge could not be reliably predicted: 103-104.
  • As a matter of tax law, it could not be said with any degree of certainty that would satisfy a prudent taxpayer (or the Tribunal) that the intended VAT consequences would even probably follow from any rearrangement of staff employment arrangements at the developments: §108. The Tribunal was wholly satisfied that the risk that HMRC might not accept the validity of either model in achieving an employment shift where VAT would no longer be payable was a real and tangible risk that it would not be unreasonable for a landlord to decline to take: §139.
  • The decision of the Upper Tribunal in Ingram v Church Commissioners [2015] UKUT 495 (LC) was potentially per incuriam and possibly wrong, not least in light of the House of Lords decision in Trustees of the Nell Gwynn House Maintenance Fund v Customs and Excise Commissioners [1999] 1 WLR 174: §142.
  • Overall, the lessees had failed to make out a ‘prima facie’ case for the Tribunal to consider; they had failed to make a coherent initial case as to an alternative course for the landlord to adopt and for the Tribunal to consider, both at the outset of the application and at all times thereafter: §146. Furthermore, the ongoing costs of the proposed alternative arrangements would exceed any VAT savings in any event: §148.

As a first instance decision of the FtT, this decision sets no precedent relating to the thorny issue of VAT incurred on staff costs. However, it is a very detailed decision of the chamber President and will be, most likely, highly persuasive in any future challenge on this issue. It well illustrates the complex questions that arise in any rearrangement of staffing on developments, particularly large and complex sites where staff are deployed between multiple blocks – and the difficulties lessees will face in making out their arguments on these points. This case may not be the last word on the VAT on staff costs issue, but it is likely to be the last word for now.

Simon Allison and Justin Bates acted for the eighth and ninth respondent landlords respectively, alongside joint tax co-counsel Michael Thomas KC of Pump Court Tax Chambers.

The decision may be accessed here.

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