A recent decision of the European Court of Justice has cast doubt on HMRC’s long held view that service charges relating to common areas follow the VAT treatment of the services supplies under a lease.

If service charges are treated as a separate supply then an additional charge to VAT would arise on both commercial and residential properties where the landlord has not opted to tax.

Landlords of commercial property which is VAT opted are not affected by this issue. However, if HMRC practice does change, landlords of residential property or un-opted commercial property will need to start to charge VAT on service charges. This may require landlords to register for VAT (if they are not registered already). Landlords should now seek to amend old leases and agree new leases to ensure that VAT can be charged on service charges pertaining to common areas. Action should not be required on old leases which are silent as to VAT because with these leases it ought to be possible to add VAT to the service charge if a change in HMRC practice starts to apply the standard rate.

Tenants who can recover VAT but do not currently pay VAT on such service charges may see this as an opportunity. They could ask their landlords for a VAT invoice on these service charges in order to recover the input VAT incurred.

In all likelihood given the uncertainty over the case, this is an issue which will be litigated in the UK courts. Watch this space!

RLRE Tellmer Property sro v Financní reditelství v Ústí nad Labem (2009) STC 2006