The much anticipated VAT tribunal decision in which Med Hotels lost its appeal against a VAT bill in excess of £7 million has huge implications for the travel sector. The case took place in the First-Tier Tribunal of the Tax Chamber and the decision of the Tribunal judge was released on 15 March 2010. This article considers the rationale behind the agency business model adopted by many bed banks and tour operators and proceeds to examine the impact that the Med Hotels decision will have on their business operations.
What is the Tour Operators’ Margin Scheme (“TOMS”)?
TOMS is a special scheme for businesses that buy-in and re-sell travel, accommodation and certain other services as principal or undisclosed agent (companies that act in their own name). If you are registered for VAT, you must normally account for tax on the full selling price of your supplies, but you can reclaim the VAT charged on purchases. Under the TOMS, you cannot reclaim any UK or EC VAT on the travel services and goods that you buy-in and re-supply since the tax on such goods or services is accounted for in the relevant Member State of the providers of such services (e.g. hotels and airlines).
However, tour operators based in the UK only need to account for VAT on the margin they make (i.e. the difference between the amount they receive from the holidaymaker and the amount they pay suppliers).
Principal or agent?
Bed banks, tour operators and internet split contractors (which are collectively referred to as “travel companies” for the purpose of this article) have a choice as to whether they act as “agent” or “principal” in their dealings with accommodation suppliers (i.e. hotels), travel agents and holidaymakers respectively. Just to clarify the meaning of the terms “agent” and “principal”: an agent is an intermediary, with authority to act on behalf of his principal and is responsible for making contracts between his principal and his principal’s customers. Since the agent is not a party to this contract, he will not ordinarily have any rights or obligations under it.
There is a range of advantages for travel companies in acting as an agent as opposed to a principal, the two main ones being:
- Avoidance of payment of TOMS VAT in relation to the sale of accommodation
To give a high level summary, where a travel company supplies accommodation as an agent on behalf of his principal, (i.e. a hotel or accommodation supplier), VAT is payable in the Member State where the accommodation is situated. Therefore, it will be the hotel’s responsibility to pay VAT in respect of the travel company’s margin. By contrast, where a travel company supplies accommodation acting as principal or undisclosed agent, he will be liable for TOMS VAT on his commission in the Member State where he is established.
- Limiting liability exposure
Based on the general principle that the contract of any agent is the contract of the principal, it is generally thought to be advantageous for travel companies to act as agents, since rights and more importantly, liabilities pass to principals. However, it is important to note that the fact that a person is an agent does not itself necessarily prevent him from incurring personal liability. In particular, under the Unfair Contract Terms Act 1977, a party cannot exclude liability for death or personal injury if caused by that party’s negligence. Following the tragedy in Corfu, where two children died from carbon monoxide poisoning due to a faulty boiler in their holiday chalet, travel agents have applied commercial pressure on travel companies to act as principals in relation to supplies of accommodation so that they become legally responsible for claims from any holidaymakers in respect of any similar incidents which might occur.
Med Hotels – the background
Med Hotels Ltd operated a website through which it sold hotel accommodation situated in a variety of destinations throughout the Mediterranean. The majority of sales were made to travel agents who would supply the hotels on to holidaymakers. A small percentage of sales were made directly to holidaymakers. HMRC had assessed that Med Hotels was liable for output tax calculated under the TOMS for a sum in excess of £7 million, on the basis that Med Hotels acted as principal in respect of the supply of accommodation. Med Hotels appealed against the assessments, arguing that for the majority of the period to which the assessments related, Med Hotels’ contractual arrangements established an agency business model.
The Tribunal’s decision
The Tribunal examined a range of contractual agreements including: (1) the terms and conditions that governed the relationship between Med Hotels and hotels; (2) the agency agreements between Med Hotels and travel agents; and (3) the booking conditions appearing on Med Hotels’ website that governed the relationship between Med Hotels and holidaymakers.
The Tribunal looked at the behaviour of Med Hotels as well as the various contractual documents. Significantly, it concluded that merely referring to Med Hotels as “agent” and the hotels as “principal” in the contractual documentation is not itself determinative of the parties’ roles. Turning to the terms and conditions with hotels first, the Tribunal took the following points into account:
- the majority of the terms and conditions imposed obligations on the hotels, with obligations of Med Hotels (such as terms setting out how Med Hotels was to market the accommodation on behalf of hotels) being conspicuous by their absence; and
- Med Hotels set its own commission and did not disclose it to the hotels. The hotels only accounted for local VAT on the net amount. The Tribunal concluded that VAT due on the amount retained by Med Hotels should have been payable by Med Hotels in the UK, but it was not. Med Hotels should have notified the hotels of its commission, issuing an invoice for this, thus enabling the hotels to be aware of the gross price paid to enable the hotels to account for the local VAT correctly.
The Tribunal then turned to the booking conditions and took the following key factors into account:
- The booking conditions stated that holidaymakers were liable to pay cancellation charges and administration charges in respect of changes made to bookings. However, there was no evidence that such charges were in fact passed on by Med Hotels to the hotels concerned;
- Med Hotels took a deposit payment from holidaymakers and would retain the accrued interest, thereby carrying the benefit/risk of currency fluctuations between payment by holidaymakers and transfer of the monies to hotels; and
- The booking conditions stated: “If in the unlikely event we are informed by the accommodation owner that they are unable to provide the accommodation which you have booked, we will try to provide you with similar accommodation of equal standard. If we are unable to do this or you prefer not to accept our alternative, you may cancel free of charge”. The Tribunal commented that this is an unusual undertaking by an agent who is not usually contractually bound in this way. It is more usual for the principal to accept the obligation to find alternative accommodation.
After taking the above factors into account, the Tribunal concluded that Med Hotels had acted as principal as opposed to agent and was liable to pay the £7 million TOMS VAT bill.
Implications of the Med Hotels decision for travel companies
The spotlight is now firmly focused on travel companies. HMRC is likely to conduct a thorough and rigorous examination of travel companies’ documentation and business operations. Key factors likely to increase the chances of HMRC finding that a travel company is not genuinely an agent as opposed to a principal include the following:
- Agreement between travel companies and their suppliers (hotels)
- standard” agent obligations (e.g. a duty to comply with the hotels’ instructions concerning the promotion and marketing of the accommodation) are missing;
- the travel company is not contractually required to pass the hotels’ booking conditions on to holidaymakers;
- the agreement does not contain a provision which requires the travel companies to transfer sums collected from administration and cancellation charges to the hotels;
- the travel company provides in-resort services;
- the travel company is able to set its own commission and does not disclose or issue an invoice for its commission to hotels meaning that hotels are unable to account for VAT based on the ultimate selling price paid by the holidaymakers; and
- the travel company deposits payments from holidaymakers in its own account and accrues the resulting interest.
- Booking Conditions issued to holidaymakers
- the booking conditions make a distinction between those payments which must be paid to the hotels (e.g. payments regarding extras such as mini bars) and those which must be paid to the travel company (e.g. cancellation charges);
- the booking conditions state that the travel company will try to provide holidaymakers with alternative accommodation and/or provide a refund if the hotels are unable to provide the accommodation originally booked;
- the booking conditions contain the right for the travel company to charge cancellation charges;
- the booking conditions provide that the travel company will compensate holidaymakers in the event they are unhappy with the accommodation or the hotel cancels bookings; and
- the booking conditions contain a right for the travel company to cancel holidaymakers’ bookings in respect of late payments by holidaymakers.
It is a well accepted fact of life that travel companies and their clients generally only read Booking Conditions and paperwork when and if something goes wrong. The Med Hotels case provides a range of compelling reasons why travel companies would be well advised to review their paperwork and business operations carefully.
This article was co-written by Richard Venables (Senior European Consultant in our Aviation and Aerospace Department) and Katie Bevan-Jones (Associate in our Commercial Department). If you would like further information or advice with regard to how this case could affect your business, please contact Richard using the contact details below.