The Sonder Europe FTT case - TOMS can apply to serviced apartment operators
posted 16th July 2023
They say that a watched pot never boils. Its apparently also true of Tribunal decisions and if I had known that taking as day off on Friday meant that would be the one day the decision in Sonder Europe Ltd would be released, I'd have taken a day off much earlier. We, along with much of the serviced apartment industry have been waiting for the Sonder decision to be released for some time, as we had hoped that this may finally shed some light on whether TOMS can be used by serviced apartment operators. In somewhat surprising, but nonetheless great, news, Sonder won its First Tier Tribunal case, meaning that using TOMS for serviced apartment operators just moved from "there's a good argument but no-one really knows for sure" to a seriously valid and much less risky option for operators. There are limitations, and we still advise applying caution, but please read on to see how this decision could really benefit your business...
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Why is TOMS beneficial for serviced apartment operators?
The Tour Operators Margin Scheme (TOMS) rules apply where a travel service is sold by a business acting in their own name and without material alteration to the person or business using the service. When these rules apply, it means that no input VAT can be recovered on direct costs of the service but that output VAT is only payable on the margin made. As there is typically very little input VAT to be recovered on the direct costs of serviced apartments (i.e. the exempt rent from landlords) there is no real disadvantage here, but the serviced apartment operator gains the advantage of only paying output VAT on the gross margin. For smaller operators, it also means that VAT registration is delayed, because the relevant figure for registration turnover purposes is the margin, and not the total turnover. This is explained further here
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What have been the issues in applying TOMS to serviced apartment operators?
The main issue with applying TOMS to serviced apartment operators is the idea of material alteration as explained further here. There has never been a formal legal definition of what material alteration is, but businesses must show that they have not "materially altered" the service they have bought in before selling on. HMRC's own guidance sheds very little light on what HMRC deem to be material alteration but its Notice 709/5 has a small point on this: "If you hire, lease or rent accommodation under an agreement whereby you take responsibility for the upkeep of the property and you are required to undertake any maintenance to the fabric of the building (that is, not just cleaning and changing towels or bed linen and so on), you are (materially altering) accommodation." Many operators have taken this to mean that as long as they do not take any responsibility for repairs and maintenance to the property, they fall within TOMS. Some have even gone as far as noting this specifically within contracts and/or obtaining signed statements from landlords to this effect, but nonetheless HMRC have often disagreed.
HMRC have stated in various cases that actually operators need to go much further than this in making sure that they do not furnish the properties, that they do not add any utilities or technologies, that the lease purchased from the landlord is a similar, if not identical, length to the supply of bednights to the guest, and that the operator has no staff or other services anywhere near the property. We have been frustrated for many years at HMRC's inconsistency on this point and, when challenged at individual appeals, HMRC have never been able to fully explain why they disagree. Even when we have cited much of the UK and CJEU case law (recently successfully relied upon by the Sonder case at tribunal), HMRC have dismissed our arguments saying nothing more than "we've considered this case and we still don't agree with you". It has been frustrating for operator and advisors in that there has been no clear advice and much inconsistency meaning that we have had to advise that applying TOMS comes with a fair degree of risk. This has been frustrating and unfair to taxpayers, and it has seemed HMRC are very much aware that most operators do not have the funds to take the matter to Tribunal. This is why we are extremely glad that Sonder has taken maters that extra step (and even more pleased at the result!).
What was Sonder's case?
Sonder rented exempt residential accommodation from third party landlords in return for an annual rent (we understand the leases were typically 3+ years) which did not change depending on the number of days the apartments were occupied. The contract between Sonder and the landlord was typical of a normal AST style contract and restricted to residential use such as "To use the Property only as a serviced apartment for the residential occupation of one or more Occupiers."
Some apartments were supplied to Sonder on a furnished basis whereas others were unfurnished (no furniture other than white goods was provided such that the accommodation could not be used until Sonder had furnished it). When Sonder furnished the properties, it did so with its own specific style, but the changes were only superficial and cosmetic in nature. Sonder never made any changes which would have altered the fabric or structure of the apartment or building, such as moving a wall or door or changing windows, and this was clearly set out and prohibited in its contracts with the landlords In its agreements, Sonder was however responsible for keeping the apartments and any furnishings, fixtures and fittings provided by the landlord as they were when they were first provided to Sonder such that it would be responsible for damages and replacements (other than wear and tear and statutory obligations) and, based on the extracts provided, the normal maintenance that many of you have within your standard AST contracts. Sonder did carry out such repairs and maintenance, but for context it spent £20k on maintenance on rents of £1.5m. There was no mention of utilities and who was responsible for paying these.
In its onwards supply to guests, Sonder did not market itself as a tour operator or travel agent. The apartments were offered on a self-catering basis only without any additional services for an average of 5 days. Sonder had no staff at the premises and check in was completed online with an access code then being sent to the guest. Sonder used a third part cleaning and housekeeping service pre- and post-stay, but not on a nightly basis throughout a guest's stay. If guests had any questions about the apartment or required any additional items such as fresh towels or toiletries, they would contact Sonder's 24 hour Hospitality Team. There was no check out procedure. At the end of the stay, the traveller simply left the apartment.
Sonder maintained that it was acting in the capacity of a tour operator and its services were subject to the TOMS rules as it was supplying accommodation to tourists and visitors without material alteration. HMRC disagreed and maintained that TOMS does not apply because Sonder was not a tour operator and that its supplies were not TOMS services due to the fact that the business has materially altered the services.
Was Sonder a "tour operator"?
One important point about this decision is that the time period in question is wholly prior to Brexit, meaning that the court has been bound by EU legislation and CJEU case law. This is not strictly speaking the case any more, and although we see no particulars disadvantage in losing the reliance on EU legislation, the presiding CJEU case law was a useful factor in swaying the decision here.
A useful addition to the UK law is that the TOMS rules apply to tour operators, travel agents and "and any other person providing for the benefit of travellers services of any kind commonly provided by tour operators or travel agents". With this in mind, Sonder did not have to show that it was a tour operator, but just that it provided services that a tour operator typically would.
The judge referred to the ECJ case in Madgett and Baldwin t/a Howden Court Hotel (a hotelier provided additional bought-in transport services, and also a UK referral to the Court) where is was deemed that TOMS applies to the bought in transport services even though Madgett and Baldwin was not a tour operator, and ISt internationale Sprach- und Studienreisen GmbH ('ISt') which provided language study programmes with a 3-10 months' language study abroad. In ISt, the CJEU stated that TOMS applies to persons who provided relevant services even if they are not travel agents or tour operators in the normal sense of the term because to apply TOMS "solely to traders who are travel agents or tour operators within the normal meaning of those terms would mean that identical services would come under different provisions depending on the formal classification of the trader."
The FTT found it clear from these decisions that the term "tour operator" should be interpreted broadly, and that Sonder was clearly supplying short term accommodation for the purpose of visitors or travellers, with no suggestion that the apartments were used as permanent or long term accommodation. With this in mind, it concluded that the apartments were therefore travel facilities for the benefit of travellers. It was then found that the provision of accommodation in self-contained apartments is the type of service that was commonly provided by tour operators or travel agents and the court did not actually understand why HMRC would think otherwise! As such, Sonder was a tour operator for the purposes of the TOMS.
To be honest, we did not really think this was a particularly worrying challenge and we were surprised HMRC decided to raise this point. Indeed, if HMRC had won this point, they must have realised that there would be many claims raised by other businesses who were "not tour operators" who had been paying HMRC lots of money over the past few years on a standard rated TOMS margin for pre-Brexit services taking place in the EU!
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Did Sonder materially alter the services?
Now to the more important question and I have to admit that I was initially really surprised that this was decided in Sonder's favour. However, I really like the judge's rationale here and find myself becoming even more persuaded in favour of TOMS for SA operators and relaxing on some of the points of risk I have raised in my own advice to clients over the past few years.
The fist point raised was that in EU law, there is no concept of "material alteration and further processing" and the court noted that this was one inconsistency between UK and EU law. For the time period the claim relates to, EU law must preside, but good news for us is that the court did not seek to shut the case down on this point alone and still gave detailed comments on the UK law provision on this point.
The first point which I really liked is that the court decided that HMRC's vague statement on material alteration in its Notice 709/5 was irrelevant, given that it does not have the force of law. This is good news for me, as I was getting quite tired of quoting that passage to everyone and having to apologise that HMRC do not appear to take their own advice on this point.
The main point in HMRC's argument relates to the lease duration, and specifically that Sonder was purchasing exempt residential accommodation and selling it on as short term taxable hotel-like accommodation. The fact that it then often furnished the properties and carried out repairs and maintenance further showed to HMRC that the business was converting the purchase of a property further into its own in-house supply of hotel-like accommodation.
The court confirmed said that there was no requirement for the purchase of accommodation to be exactly the same state as it is sold on in both in EU and UK law. EU law states that the service must be used "in the provision of travel facilities" and does not have to be the travel facility itself. In UK law, the idea that the services are provided without material alteration or further processing does not mean that the bought-in supplies must be identical to the supplies provided by the tour operator to the traveller. There are several ECJ cases in including Van Ginkel and Alpenchalets (which we have mentioned to many of you in our discussions previously) where only the onwards supply was referred to as the "hotel" or "holiday accommodation" and not the purchase. With this in mind, the judge said that "In my view, the nature or characteristics for VAT purposes of the goods and services supplied by third parties to the tour operators do not determine whether onward supplies fall within the TOMS". The purpose to which the apartments had been put by the landlords was irrelevant to the VAT treatment of the onward supply of those apartments by Sonder.
The judge confirmed that a change from letting the apartments for a term of years as accommodation, to letting them as, as Sonder did, for holiday accommodation did not amount to material alteration or further processing and in his view "the object of the alteration or processing must be the thing supplied, ie the apartment, not the characterisation of the supply for VAT purposes". This was supported by the CJEU case of ISt, where the supply of exempt language tuition became taxable as a TOMS supply. This conversion from exempt to taxable was my own main reservation about the material alteration point and so this gives me the most comfort in the whole decision. It follows that the correct question in this case is whether the apartments themselves, and not the tax status of their supplies, were materially altered or further processed before they were supplied by Sonder to the travellers.
On this point, the judge has said that the cases he was referred to through in UK case law were not of use, and so these have not been used within the decision. Instead, the judge said that "It seems to me to be clear from the nature of the TOMS that "material alteration or further processing" must refer to more than minor changes or processes which do not affect the fundamental character of the particular goods or services...In order to be excluded from the TOMS, I consider that the alteration and processing must change the goods or services supplied so that what is supplied by the tour operator cannot be described in the same terms as the items acquired". With this in mind, whether or not the apartments were furnished or unfurnished did not matter because in both types of supply, Sonder supplied the apartments to the travellers without changing their structure and changes were cosmetic only, and could be reversed simply by removing the items of furniture or re-painting a wall. As such, it was ruled that Sonder did not materially alter the apartments.
Another interesting point in the context of EU law was that the purchase must be from a "taxable person". HMRC were arguing that a landlord who is unregistered for VAT was not a taxable person. We were comfortable with this anyway, in that the EU legislation defines 'taxable person' as any person who, independently, carries out in any place any economic activity, but it is useful to have this confirmed in the decision.
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What does this mean for SA operators?
This case is great news for operators seeking to use TOMS. It gives us a level of comfort in what has been a frustratingly uncertain and inconsistent area for many years due to HMRC's lack of clarify and foresight and I think many of us are quite surprised at the strength of the decision in Sonder's favour! However, it does not give us free rein to apply TOMS to all serviced apartment operators in all circumstances.
For starters, HMRC can appeal (and I would not be surprised if they choose to do so given that this industry is growing and there are several cases piggybacking onto this one, so some large numbers involved). We should know whether this is the case or not in the next couple of months. If so, it may be many years until a decision is ultimately made, and so there would be a risk attached to anyone deciding to use TOMS in the same circumstances based on this First Tier Tribunal decision alone.
Secondly, the judge pointed out many times that the court was bound by EU legislation and case law within the period to which the claim rates. This is not the case anymore, and I do wonder if we would get a different result without the precedence of the CJEU cases referred to and the fact that the idea of "material alteration and further processing" does not appear in EU law. Although there are not huge disparities between UK and EU law, it would be unwise to assume that the case would proceed in exactly the same way without the reliance on these cases.
Thirdly, a lot of emphasis was placed on the fact that the UK had to follow EU law prior to Brexit. This is not the case any more, and if HMRC want to try and get to a place where TOMS only applies to tour operators and does not apply to single sales of hotel accommodation (or whatever else they decide to try and make things as painful as possible for SA operators!) this could happen in due course. There has been no suggestion of this yet but, having lost a case such as this, HMRC may instead decide to look to the future rather than dwell in the past. This would mean that although TOMS would be permissible in some circumstances now, it may only be short lived (until we find a way to legitimately argue against any new future provisions!).
Finally, remember that even where a case is won by a taxpayer, it does not give everyone the go-ahead to use the same treatment. There are many things the case does not tell us, and unless your circumstances are identical to Sonder's, there is still a risk involved.
What next?
I think the decision is a really promising result, and it gives me comfort in the advice we have provided to our clients on their set-ups and contractual positions, in what has been a very uncertain time. We have always warned businesses that using TOMS for serviced apartment supplies comes with a risk, but with this decision we take comfort in that this risk must now be lower.
I would advise our clients to continue with the set-ups we have discussed for their businesses (which are relatively inexpensive to run and add very little complexity to the business), and not instead seek to replicate Sonder entirely as there is still a good degree of risk associated with a decision which is currently just at First Tier Tribunal stage. For those of you who have not spoken with us previously and are thinking of using TOMS based on this decision alone, I would ask you to apply some caution and consider the risks attached to this. The decision was released less than one working day ago as I write this, and I have already heard from several people saying that they are now planning to use TOMS based on this only. Instead, I would advise building on this decision and making your own position as tight as possible based on the facts and comments above as well as all the other conditions required to get the best out of TOMS for your business.
We promised to run a webinar for serviced apartment operators once the decision was announced which will address the position for operators going forward in general. A date for this will be announced in due course and will contain a
For anyone who would like to discuss TOMS and serviced apartments, please contact us.