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.
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Welcome to this month’s update by Lexis®PSL Property!
In this month’s update, we look at: (1) joint ownership (establishing beneficial shares), (2) Trusts of Land and Appointment of Trustees Act 1996, (3) VAT on residential service charges and (4) town/village greens.
What property issues have been causing nightmares this year? Our panel of experts give their views.
The experts
James Styles, real estate consultant at Stephenson Harwood
Ben Stansfield, environment and planning partner at Stephenson Harwood
Miri Stickland, property business support lawyer at Forsters
Brie Stevens-Hoare QC, barrister and mediator at Hardwicke
Joanna Bhatia, solicitor in the Lexis®PSL property team
What legal ghost from the past is still haunting you and just won’t go away?
James Styles: My ‘trick or treat’ topic would be exclusivity agreements—where sellers give buyers a window of time to do their due diligence, during which time the seller won’t negotiate with anyone else.
Commercially, exclusivity agreements sound like a no-brainer and should be easy to document. In reality, this is a trick, as sellers and buyers both want, and think they are getting, different things. Sellers think the buyer will definitely buy unless they discover something so fundamental that the property is unsellable (which they’re confident there won’t be because they’re sure their lawyers did a great job when they bought the property, right?). Buyers think they have a definite right to buy the property if they want to, but don’t want to be under any obligation to do so (because while the property looks good they haven’t decided whether they want to buy or if they’re really happy with the eye-watering price that they agreed to secure the deal). Therefore, in reality there is no meeting of minds.
Explaining to the parties that, instead of killing all the goodwill and wasting vast amounts of time (and money), the best thing to do is to simply set a tight timetable and get on with it is a treat. The cherry on the top is getting to an actual exchange in less time than it would have taken to agree the exclusivity.
Ben Stansfield: My ‘trick or treat’ topic is permitted development rights (PDRs)—the ability to undertake development with the express grant of planning permission from the local planning authority.
PDRs demonstrate just how political town and country planning really is. PDRs change frequently—I can’t think of any other statutory instrument which has been amended as often in the past five years. The trick posed by PDRs is the uncertainty surrounding them and the frustration that commercial developers have when trying to rely upon them. A few years ago, changing the use of a building from office to residential use became a PDR. There was a great deal of excitement in the market, until developers saw the residential use had to have ‘begun’ before the end of May 2016. The works to change the use did not need to have begun (like implementing a planning permission), but the use needed to have started ie someone had to be living there, eating rich tea biscuits and making cups of tea.
Fortunately, the political nature of PDRs means that changes can be effected speedily—earlier this month, the Housing and Planning Minister, Brandon Lewis, announced that office to residential changes become permanent PDRs and my ‘tea and biscuits’ test will never be tested. Hurrah for common sense. In addition, the cherry on the top with PDRs, is that there will now be a right to demolish offices to bring forward residential uses—no need to work with the constraints of a 1960s office block any longer.
Miri Stickland: Although it is not entirely specific to property, I would say one of the key concerns is the sophisticated fraudulent activity that law firms are encountering—requiring further protections and procedures to be put in place at law firm level. The interplay between this and the Land Registry’s push to move to an entirely paperless registration system is an interesting one, with original documents no longer required to be submitted for the bulk of Land Registry applications.
While the Land Registry has already moved to put increased anti-fraud measures in place (such as the free property alert service which allows you to monitor significant activity that may result in a change to the register of up to ten properties) no doubt further steps safeguarding the security of the system will be required on an ongoing basis.
Brie Stevens-Hoare QC: Currently for me the scary bits of the legal framework in which property development takes place are:
the growing reach of right to buy legislative provision, and
the disparity between the need for housing that is actually affordable for ordinary working people and the shrinking provision for largely unaffordable ‘affordable housing’
I worry that our amazing vibrant capital city will be changed by too many flat-sized safety deposit boxes and not enough homes for the diversity of its residents.
Joanna Bhatia: One area that certainly puts the shivers up many a property lawyer is the law on former tenant and guarantor liability. The decision in K/S Victoria Street v House of Fraser (Stores Management) Ltd[2011] EWCA Civ 904, [2011] All ER (D) 262 (Jul) provided clarity to some extent, but the decision has affected business, particularly in relation to the assignment of leases between group companies. Unfortunately, while the proposals for The Law Commission’s twelfth programme of law reform suggested addressing the property sector’s concerns in this area, the issue did not make the ‘final cut’ and so is not part of the twelfth programme.’
Interviewed by Nicola Laver.
The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
LexisPSL Property will be hosting a networking breakfast seminar: Breakfast and Brexit, on 24 November, in conjunction with our expert and experienced speakers, Tim Eicke QC of Essex Court Chambers, James Roberts of Knight Frank and Chris de Pury of Berwin Leighton Paisner.
This networking event and seminar is designed to bring together interested parties to discuss, debate and make sense of what a Brexit, or a renegotiated position within the EU, could mean for us in the Property industry and our key clients and stakeholders.
We know some of the reasons prompting a review of our relationship with the EU. David Cameron is in talks with his counterparts to try to bring back sovereignty, cut red tape, curb immigration and reduce our unequal contribution to the pot.
What is less certain in the run up to a 2017 referendum is whether we will be able to negotiate a better position. If so, what would that look like? If we can’t, and we vote Out, what impact will this have on the Property industry immediately and longer-term?
We hope this seminar will go some way to pooling the collective intelligence and equipping us all with a sound sense of the pros and cons and potential impact of a Brexit on our industry.
Location:
Lexis House
30 Farringdon Street
London
EC4A 4HH
Itinerary:
8.30am: Arrival and breakfast
9am: Brexit seminar
10am: Coffee and networking
Spaces for this event are limited, so please do register your place as soon as possible by emailing events.inbox@lexisnexis.co.uk.
Regards,
The LexisPSL Property team
LexisPSL Property provides up-to-date legal practical guidance with industry insight for property professionals. In the face of pressure to work profitably in a competitive marketplace, LexisNexis tools equip you to work smarter and faster. All our guidance comes with direct links to the underlying case law and authority in LexisLibrary, the UK’s most authoritative and comprehensive legal library.
On-site issues can lead to delay and crippling costs, but what can be done to minimise the risks posed by site disruption? Jonathan Hosie and Chris Fellowes, construction and engineering partners at Mayer Brown International LLP, consider the challenges facing construction sites and the best ways to mitigate the risks.
What are the challenges facing large-scale construction projects in terms of site management?
There are a number, for example:
logistics planning, particularly for brown field city centre developments
highway closures
neighbourhood issues, including rights of light and crane over-sailing
Cranes are a continual problem in cities. If a crane is to over-sail a property proper agreements and indemnities have to be put in place which can affect the timing of a project. To avoid such issues, luffing jib cranes, which don’t over-sail neighbouring sites, can be used instead but they are more expensive. Practical issues like this present a range of problems.
Well organised sites tend to have a better health and safety record and better productivity rates. On-site accidents necessarily lead to investigations by the Health & Safety Executive, sometimes site closure and inevitable production delays. They are therefore costly in financial terms, as well in terms of the physical injury caused to the victim.
A lack of skilled site management resources is also a problem. We don’t pay experienced and skilled site managers enough in the UK and so there is a shortage of them. This is being partly addressed through apprenticeships, but generally there are just not enough skilled people around to do the job.
How can lawyers assist in negotiating with the local authority as to terms of access, disruption etc?
Lawyers can help client developers with the negotiation and drafting of ‘section 38’ agreements (Highways Act 1980). These are used for the adoption of new estate roads. Local authorities tend to have a wish list of things they want developers to provide in terms of municipal amenities—from new roads, to roundabouts, walkways, open community spaces—all of which will be part of the planning consent process. Developers build them and later the authorities take them over and maintain them. An important part of section 38 agreements is the date on which the local authority adopts responsibility for the roads which is also the date for the completion of the work. This is a watershed date and the contractor usually can’t get its final payment until this time.
Ensuring that neighbouring property owners also get early notice of plans so you can manage party wall issues is something lawyers can help with. They can also help deal with rights of light and crane over-sailing licences. A lack of objection in the early planning and consultation stages will affect the neighbour’s right to get an injunction to stop the development later on.
How can developers insulate themselves from claims from residents/business owners?
As discussed above—failing to plan is planning to fail. However, the passing of the risk of claims onto contractors is becoming increasingly difficult. This is just due to market forces. If a contractor decides it does not want to assume the risks which are intended to pass onto it, the developer has less of a choice of contractors. Currently, therefore, contractors can drive a harder bargain. Developers should also fully investigate the possibility of insurance from such claims.
Should potential litigation costs be factored into any funding arrangements?
If a proper risk analysis is undertaken (culminating in a matrix with risks ranked small, medium and high in terms of both likelihood of occurrence and effect), this should inform the developer as to the prudent allowances to include for high probability/high impact risks. This could include a litigation cost allowance (or more likely, adjudication risk).
However, it is better to plan for risk mitigation. For example, early consultation with neighbours, adopting proper party wall procedures and addressing problems before they mushroom out of control are all perhaps obvious points but are not always observed in practice. These practical decisions can have a high impact on the potential for litigation. Having early consultations and operating a charm offensive with neighbours are also an important part of community dialogue and may indicate a robust process which will form an important part of the developer’s pitch when it comes to obtaining finance—credit committees need to be persuaded the developer has addressed the likely risks and has a clear strategy for mitigation and control of that risk.
What have been the key cautionary tales in terms of disputes around construction sites?
Inadequate resourcing—both on the contractor and client side—can really lead to problems and delays and litigation.
Also, a lack of pre-planning—that is, entering into a construction contract with insufficient information—leads to problems that could have been avoidable. Rights of light and party wall risks—if not allocated to the party best able to manage them—may end up with the developer being held to ransom by neighbouring owners. The ‘ransom strip’ may literally be the only means of access to realise the development potential of an otherwise stranded site or it may be the consent needed to avoid an injunction to protect other proprietary rights. These are risks that need to be identified in advance by proper due diligence. Where that due diligence is not undertaken, problems arise. These are most commonly on brown-field developments.
Interviewed by Diana Bentley. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.
If you are a Client and we have made a contract with you by electronic means you may be entitled to use an EU online dispute resolution service to assist with any contractual dispute you may have with us.
This service can be found at ec.europa/consumers/odr
Our email address is glg@hardwicklegal.com.
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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?
