In the mix or out of hand? Recent residential service charge lessons

by Hardwick Legal | Nov 10, 2015 | Purpose Built (LexisNexis)

Should residential tenants in mixed use premises pay the real cost of insuring the whole of the mixed use block including the normal commercial use of the commercial premises?

In what circumstances should residential tenants contribute to the cost of insuring for property owner’s liability through the service charge where it is placed solely for the benefit of the freeholder and did not provide any cover for the tenants?

Can VAT payable on the salaries of staff employed by managing agents be passed on to residential tenants through the service charge?

These issues were considered by the Upper Tribunal (Lands Chamber) (UT) in two recent cases which we explore in this post.

Liability for insurance premiums between tenants of mixed use buildings

In Sadeh v Mirhan and Azzniv (Charitable Trust) [2015] UKUT 0428 (LC), the dispute centered on the service charge and insurance payable by residential tenants in a mixed use building.

What was the dispute?

The residential tenants argued that the insurance covered risks which were not envisaged by their leases and which could not properly be charged for through the service charge - both in terms of commercial weighting and on property owners’ liability.

Commercial weighting

The residential tenants argued that they should not have any obligation to contribute to the commercial weighting of the premium attributable to the commercial unit on the ground floor (a dry cleaners) whether directly or via the service charge. Instead, their liability should be calculated as if the property was 100% residential.

What did the UT say?

• The residential tenants could not claim that they were only liable as if the building was 100% residential rather than mixed use i.e. on the basis that it was something that it was not.

• The UT referred to a leasehold valuation tribunal’s (LVT) decision in Ralph v Peachey (BRI/39/UF/LSC/2009/0018) (although not binding) where the LVT had approved the landlord’s method of calculation where part of the building was used as a fish and chip shop. The Landlord in that case obtained a quote for the building insurance as if the fish & chip shop was occupied as normal risk commercial premises, such as a gift shop. With that information the broker had calculated that part of the premium which represented the high risk posed by the fish & chip shop.

• The matter was referred back to the FTT with the direction that the tenants should be required to pay two thirds (on the basis of floor areas) of the premium which would be payable if the ground floor unit at the building was a normal risk commercial occupier and not a dry cleaner. The element attributable to any extra risk associated with the dry cleaners should be taken out of the equation.

Property owner’s liability

The tenants also argued that part of the insurance premium - relating to property owner’s liability - should not be included as part of the service charge, claiming that:

i) the wording of the provisions of the lease did not permit such a charge; and

ii) the insurance was placed solely for the benefit of the freeholder and did not provide any cover for the tenants.

What did the UT say?

Again they referred to Ralph v Peachey which also considered the issue of payment for property owners’ liability. In that case:

• the covenant to insure was limited to risks of loss or damage to the property; and
• insurance against personal losses by way of liability to third parties was not within the words of the covenant; and
• the tenants’ interest had not in fact been noted on the policy in respect of this aspect of the insurance

In this respect, Sadeh mirrored Ralph.

However, the lease in Sadeh, contained an additional clause which stated that the landlord would:

“…do or cause to be done all such works installations acts matters and things as in the absolute discretion of the Lessor may be necessary or advisable for the proper maintenance safety and administration or the Building.”

The UT said this was wide enough to cover property owners’ liability insurance.

While the UT lacked the evidence to decide the point (and so referred the matter back to the FTT) the tribunal did confirm that if the property owners’ liability insurance had been placed in a way that it actually covered the tenants then the cost of the insurance premium attributable to property owners’ liability was reasonably incurred and would form part of the service charge.  If it did not, then that part of the premium was not reasonably incurred and should not be included as part of the service costs.

Tenants liable for VAT charges on services outsourced by landlord

Ingram v Church Commissioners for England [2015] UKUT 495 (LC) concerned a dispute about whether or not VAT charged to the landlord for services could be included in service charge.

What was the dispute?

Ingram was the long leaseholder of a residential flat. The Church Commissioners (CC) were the freehold owners.

The lease included an obligation on CC to employ others (whether employees or agents) to undertake and fulfil its other obligations as landlord under the lease.

CC could, incur such costs as were necessary and desirable to achieve these ends and they were to be ‘fully and effectually indemnified’ in respect of such costs.

CC employed agents (KF) to meet these obligations. KF employed caretakers and the like to maintain and look after the building and invoiced CC the salary costs. This service provided by KF to CC attracted VAT and CC sought to recover this from Ingram via the service charge.

What did the UT have to decide?

Firstly, should KF have charged VAT at all?

If not, it was unreasonable of CC to have incurred VAT charges and in accordance with the Landlord and Tenant Act 1985, s 19, they should not form part of the service charge.

VAT is not payable on the provision of residential accommodation (the Value Added Tax Act 1994, s 31 (VATA 1994) and therefore, if the services provided were in the nature of rent, no VAT should have been charged.

The mandatory provision by the landlord of services closely aligned with the provision of accommodation will not attract VAT. When a third party provides those same services and charges VAT, VAT Notice 48 paragraph 3.18 may come into play as it provides a further statutory concession from payment of VAT. The concession applies to ‘the upkeep of the dwellings or block of flats in which they reside and towards the provision of a warden, caretakers and people performing a similar function’.

Ingram said that this meant that as the ultimate payer, no VAT was payable all down the line.

What did the UT say?

The UT did not agree with Ingram. Crucially in this case, VAT was not being charged directly to the Ingram but rather to CC. In analysis,

• charges paid by a residential occupier to the landlord which are in the nature of rent, being directly related to the tenant’s right of occupation, are exempt from VAT by virtue of VATA 1994, s 31 and Sch 9, Pt II, Group 1;

• charges paid by a residential occupier which are not rent because they are owed to a person who does not supply any accommodation falls within the concession in VAT Notice 48 paragraph 3.18 and are exempt from VAT provided they are paid ‘towards the upkeep of the dwellings or block of flats in which they reside and towards the provision of a warden, caretakers and people performing a similar function for those occupants’;

• the concession does not apply to any charges paid by the landlord to third parties for the supply of services even if these services are ultimately passed on to a residential occupiers through a service charge.

So, where a landlord directly employs staff and passes the cost to tenants in a service charge, VAT is not payable on the salaries. But if the same staff are employed by a managing agent who recharges the landlord the salary cost, VAT is payable on the service and passed to lessees through the service charge.

As the judge pointed out:

“Given that the standard rate of VAT is 20%, this could give rise to significantly increased service charges. That may potentially give rise to an argument as to the reasonableness of properties being managed in this way and that the VAT thus passed on via the service charge is not reasonably incurred for the purposes of s 19 of the 1985 Act”

Practical points to note:

• In Sadeh the UT made the point that the residential tenants in mixed use building knew that they were not buying into a purely residential scheme and therefore could not complain that the insurance premium was one appropriate to a mixed use building (bar any high risk element) - advise tenants acquiring property in mixed use premises that their contribution to insurance costs may be higher than if they were purchasing purely residential property.

• Whilst many leases include cover for property owners’ liability in the insurance costs towards which the tenant is obliged to contribute the UT suggest that that alone will not suffice for it to be recoverable from tenants, the landlord must actually make sure that the cover extends to tenants- advise landlords providing property owners’ liability insurance to ensure it covers tenants if they intend to recoup the cost via service charge.

• Ingram makes the point that it is important to consider the way services are (or can be) provided by a landlord. The question of whether an increase in cost (through the payment of VAT) on outsourced services has been reasonably incurred for the purposes of section 19 of the 1985 Act was left open but it would be for a landlord to show that they are.

Source: LexisNexis Purpose Built
In the mix or out of hand? Recent residential service charge lessons