9:28 AM, 18th February 2025, About a month ago
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The Rent to Serviced Accommodation (R2SA) Upper Tier Tribunal decision appealed by Sonder is leaving hundreds of operators in a quandary of what to do next.
When the UK legislatures transcribed yet another EU VAT directive many moons ago, they would not have conceived of Section 24 and certainly would not have imagined that training room seats would be sold on the exciting opportunity that landlord owners would be forced to rent their properties to a young inexperienced entrepreneur market at less than the market rate, in order for them to be furnished and relet via online platforms such as Booking dot com, Expedia and AirBNB.
But governments continuously adapt to their latest creation of unintended consequences and this example was entitled TOMS.
The Tour Operators Margin Scheme was the UK translation of articles 306 – 310 of the EU VAT Directive. The directive’s design was to simplify the administration of VAT for cross-border operations of large tour operators which provide packaged holidays. Whether this was a four-star hotel in a cliff enclosed cove in Menorca, a ski holiday in Val D’Isere or a cycling tour around Scandinavia, the tour companies generally contracted the rooms, flights, bus transfers and other services in advance of the season and sold these packages to the UK tv audiences. The problem was the very difficult administration of VAT reclaim from all these procured services to offset the VAT due on the holiday price. EU countries have independent VAT rules, rates and thresholds and it is practically impossible to obtain the necessary paperwork and then convert the currency to arrive at a fair VAT reclaim.
Further, the numbers are very high. Whilst the customer pays the total cost of the holiday, the promoting tour operator simply makes a margin on the buying and selling price, often sacrificing negative margin at the nether ends of the season for the gain of the school holiday trade.
TOMS simplifies this by applying VAT only on the margin of the operator in qualifying circumstances.
Wind the clock forward to the invention of social media and a wealth generation industry, when it became apparent that the R2SA market was quickly emerging due to its promotion by training companies, an alert accountant saw the opportunity to enable these operators to grow well beyond the VAT threshold without registering for VAT by employing the TOMs scheme. Once this message got to the front of the room, more seats were sold and more landlord owners received approaches from these budding entrepreneurs.
They could have kept it simple and offered services akin to a letting agent. This had other selling benefits because an overarching contract between owner and guest meant the owner would reclassify the income from investment buy to let to the hybrid FHL class (which is being abolished at the end of this tax year). In such cases, this has enabled the owner to make considerable tax savings by claiming capital allowances that were prohibited with buy-to-let. It also meant that the owner would not be affected by the S24 legislation and could recover the full mortgage interest.
Whilst many have adopted the “agency model”, those that took on longer leases or corporate let contracts (popular but legally inappropriate) were happy to consider themselves under the scope of TOMs and, therefore, not required to register for VAT until their margin exceeded £90k, which in many cases has not occurred.
Some FHL property owners adapted this opportunity by setting up their own rent-to-rent companies that rented the properties from the company owner. This was a clear VAT avoidance mechanism which is now being challenged.
Whilst the emergence of this property sector and the “too good to be true” tax advantages appeared to cause raised eyebrows with many professional advisors, it wasn’t until HMRC challenged Sonder that the matter was formally brought into question.
Previous articles on this news site have covered the arguments of the case, which are not of great interest to the main readership, due to their technicality. If you want to understand the interpretation of “material alteration” or “purchased for the benefit of the end customer” then this article explains it (LINK).
The rollercoaster of this argument is that HMRC failed in their challenge at the First Tier Tribunal, which gave more confidence to the sector. But the UTT decision came much sooner than expected in January 2025 and overturned the decision of the FTT in favour of HMRC.
All eyes turned to valentines day, being the deadline for appealing the UTT decision. Yesterday, it was announced that Sonder has applied for an appeal and we await the court to determine whether the appeal will be allowed.
Assuming the appeal goes ahead, this provides breathing space and possible exoneration for these R2SA operators, the vast majority for whom this ruling makes the difference between survival and insolvency.
Despite the likely fatal tax assessments with interest and potential penalties, the operators report that their profit models would not sustain a VAT charge. This is likely due to market saturation as the training rooms keep churning out more hopefuls.
One ought to have a fair amount of sympathy for these budding entrepreneurs, many of whom compensate for their lack of business experience with reliance on mentors and referrals to helpful professionals. It does feel that they are the hard-working victims of a sector where the bulk of the end customers’ money goes to the property owners, professionals and the wealth creation industry.
Whilst the appeal defers the situation and keeps the VAT man at bay for the time being, it will be interesting to see what the advisors will countenance in the meantime.
Those who carry on regardless are rolling the dice and banking on a successful appeal. They may use the time to accrue profits which may cover the VAT bill in the event of the appeal failing. But for every additional day of business, the potential VAT liability increases. If the appeal is successful, they will emerge victorious.
Others are considering whether to convert the model to normal VAT. This would restrict the profits going forward and make it harder to build a fund for a potential future assessment. It will also highlight a disparity of VAT treatment before and after the change, making them very exposed to future challenge.
Others may close their business today and reopen with the “agency model” to remain below the VAT threshold and accrue profits for the potential rainy day ahead.
Others will undoubtedly close the business and sweep it under the carpet, dust themselves down and seek the next emerging opportunity that the property sector conceives.
Sonder has proven yet again that tax law is not black and white. It is so complex that advocates can highlight minuscule technicalities and expand these to be the main focus of the argument, often to the detriment of the intent of the legislation.
The one thing that is clear is that the R2SA industry has exploited TOMS to its advantage and put its head above the parapet. Neither the EU directive, nor the UK legislatures intended to provide a tax advantage to intermediaries that would result in the further reduction of household rental stock during a period of uncontrollable immigration.
