VAT Risk for Property Investors Following Rent to Serviced Accommodation (R2SA) Business Models
For years, the Rent to Serviced Accommodation (R2SA) business model has been touted as an affordable entry point into property investment. Widely promoted by property education courses, this approach involved leasing residential properties, setting up Limited Companies, and subletting them as short-term rentals under the Tour Operators’ Margin Scheme (TOMS). However, the recent HMRC v Sonder Europe Ltd Upper Tribunal decision has turned this strategy into a potential financial minefield.
The impact is extensive, affecting not only future VAT obligations but also previous tax periods. HMRC could now review past VAT filings, forcing businesses and directors to quickly assess their liabilities—and in some cases, safeguard their personal assets.
The Ruling That Changed Everything The Sonder Europe ruling clarified that many R2SA businesses are not eligible to use TOMS to reduce VAT liabilities. Key points from the Tribunal included:
- Long-Term Leases: Properties leased on a long-term basis for subletting as short-term accommodation do not meet the criteria for services purchased for resale under TOMS.
- Property Modifications: Furnishing or modifying properties disqualifies them from TOMS, which only applies to minimal processing.
- Historical VAT Risks: HMRC has the power to assess and reclaim underpaid VAT, with possible penalties and interest.
As a result, businesses will now need to account for VAT on the full value of their supplies, not just their profit margins. This could lead to a significant 20% increase in tax liabilities—a potentially crippling financial burden for many.
Is HMRC Targeting Directors Personally?
The decision also raises an important question: could HMRC attempt to pierce the corporate veil? Directors of R2SA businesses operating through Limited Companies often assumed they were protected from personal liability. However, HMRC could hold directors personally responsible under certain circumstances, including:
- Fraud or Misrepresentation: If HMRC uncovers deliberate VAT underreporting or misuse of TOMS, directors could be personally liable.
- Misuse of Company Funds: If directors took dividends or loans while VAT liabilities were unpaid, it could lead to claims of improper use of company funds.
- Negligence or Recklessness: Directors who fail to seek proper tax advice or neglect VAT responsibilities could be exposed to negligence claims.
- Insolvent Trading: Directors of companies continuing to trade while unable to pay tax debts could face personal liability under insolvency laws.
As one tax specialist warned, “HMRC is increasingly aggressive in pursuing directors personally when it believes the corporate structure is being abused.”
Historical VAT Liabilities: How Far Back Could HMRC Go?
Under VAT regulations, HMRC can revisit past returns for up to four years—up to 20 years in cases of deliberate misrepresentation. This means R2SA businesses that followed TOMS guidance might face:
- Backdated VAT Assessments: Full VAT liability on all rental income, not just on the margin.
- Penalties and Interest: Additional charges that could significantly increase the total liability.
- Personal Financial Risk: In cases of negligence or misuse, directors could be held personally liable.
As one VAT adviser cautioned, “The combination of backdated liabilities and penalties could bankrupt even well-established businesses.”
The Role of Property Education Courses
Many R2SA operators were introduced to this business model through property education courses that oversimplified VAT compliance. While these courses promised quick financial success, they often overlooked the complexities of VAT law and the risks associated with using TOMS.
One operator who followed the course’s advice stated, “I followed the course recommendations to the letter. Now I’m facing years of backdated VAT and don’t know how to pay.”
The Sonder Europe ruling raises the question of whether these course providers could face scrutiny for promoting models that may not align with VAT regulations.
What Should R2SA Businesses Do Now?
If your business followed the R2SA model, it’s essential to take immediate steps to reduce potential risks:
- Review Past VAT Filings: Consult with a VAT specialist to determine whether your filings are in line with the latest interpretation of TOMS.
- Engage Legal and Tax Advisers: Seek professional advice to fully understand your liabilities and potential solutions.
- Proactively Contact HMRC: Voluntarily disclosing any underpaid VAT can reduce penalties and show good faith.
- Explore Restructuring Options: Consider shifting to new business models that minimize VAT risks while staying compliant.
- Protect Personal Finances: Be cautious about blurring the line between personal and company funds, which could expose directors to personal liability.
