Tribunal upholds penalty for careless behaviour on VAT error HMRC failed to identify in inspections

16 February 2024

In addition to a recent finding that a recent or uneventful VAT inspection is no protection from an HMRC assessment for VAT errors, the First-tier Tribunal (FTT) has now decided that a business’s failure to proactively review its VAT position meant it was also liable to a penalty for careless behaviour. 

The Realreed case

Property company Realreed let out 200 flats located in London as serviced accommodation to private leisure travellers and to businesses seeking temporary accommodation for their employees. From the time the business began in 1989, Realreed treated these lets as a VAT-exempt rental of property, although VAT was charged by an associated company on the separate supply of related services such as Wi-Fi, bed linen and housekeeping provided to guests. 

In 2019, HMRC decided that the lettings were subject to VAT on the basis that the accommodation offered was similar to that of a hotel. HMRC assessed the company for output VAT it believed should have been accounted for during the previous four years, and also imposed a penalty for careless behaviour in respect of this error. 

Legitimate expectation

As reported in Tax Voice in October 2023, the company brought judicial review proceedings against HMRC in the High Court concerning HMRC’s failure to raise this as an issue on 11 VAT inspections it had conducted on the two companies since their creation. However, the High Court rejected Realreed’s argument that it was not liable for retrospective VAT liabilities on grounds that HMRC’s conduct had given it a ‘legitimate expectation’ that its VAT treatment was correct.  

The latest decision

The case has since been referred to the FTT to consider the correct VAT liability of the underlying supply. It has supported HMRC’s conclusion that the rental of the serviced apartments was subject to VAT, and has also upheld HMRC’s penalty, agreeing that the company’s error (in treating the lets as exempt rather than standard rated supplies of hotel accommodation) was ‘careless’.

The FTT found that Realreed had not exercised the level of diligence and care in submission of its VAT returns that a reasonable taxpayer in its position would have taken. The company had not sought advice on the VAT position of its supplies since at least 1991, nor had it carried out an internal review of the position, despite having made gradual but significant changes to its business model in response to evolving market conditions. The FTT highlighted an increase in the number of short-term rentals of the apartments and the need to advertise them alongside hotels on booking apps as material changes that might affect the VAT position.    

The complexity of the VAT rules differentiating between exempt lets of residential property and hotel accommodation did not excuse Realreed from this penalty either, as the company had failed to take any proactive steps to review its VAT position. In contrast, had the company proactively attempted to review the position but, due to the complexity of the law, arrived at the wrong answer, the FTT implied that it may have been regarded as having taken reasonable care when submitting its VAT declarations and not be liable to a penalty. 

Impact for other businesses 

The FTT’s decision on the liability of the serviced apartment rentals applies a strict interpretation of what constitutes hotel accommodation. Businesses in the real estate and leisure sectors that treat similar property lets as exempt from VAT should compare their activities to the findings in Realreed and consider whether HMRC might regard their supplies as standard rated for VAT purposes. 

However, the impact is not confined to those sectors. The Realreed litigation confirms two key risk areas for businesses in general.

  • An uneventful HMRC inspection does not mean a clean bill of health for VAT (or other tax) purposes. HMRC may assess retrospectively to correct an error, even when it appears to have tacitly accepted a fully disclosed VAT treatment on numerous occasions in the past.
  • It is important to periodically review VAT treatments. Business models often evolve over time due to changing market conditions and the FTT has confirmed that failure to recognise the VAT implications of this can be interpreted as careless behaviour, resulting in penalties where errors arise. 

Businesses should schedule reviews of their overall VAT position every few years and consider obtaining HMRC rulings on any points of uncertainty. This is particularly important for those that might have previously decided not to approach HMRC for rulings on contentious or unclear VAT treatments because they were not raised in a recent VAT inspection. 

For more information, please get in touch with Ian Carpenter, or your usual RSM contact.

Ian Carpenter
Partner, Head of Indirect Tax
Ian Carpenter
Partner, Head of Indirect Tax