5 Disputes that rocked service charge accounting

Every now and again service charge disputes have a significant impact on service charge accounting and reporting. Gordon Whelan, Managing Director of Haines Watts Service Charge looks at five examples of disputes settled through the Courts that have rocked the world of service charge accounting.

Reserves – Are they adequate but not excessive?
Syed Balakhi v Southern Land Securities Limited [2016] UKUT 0239 (LC)
The above dispute is an important case for all professionals operating in residential property management. The case involved a reserve fund for future expenditure on a 100 year old property in Mayfair. Common sense suggests that such a property would require substantial reserves in place to cover major works that might be required in the future. However, Mr Balakhi did not see this as a foregone conclusion and he challenged the landlord to prove that the amount requested for reserves was reasonable.

The landlord was unable to substantiate the amount claimed and a tribunal ruled in favour of Mr Balakhi. The lesson of the dispute is clear. Reserves set aside for future expenditure need to be supported by professional evidence either through a well thought out planned maintenance programme or a detailed surveyors report.

This case marked an end to “big bucket” reserve accounting and caused a rethink in the way we approach reserves at Haines Watts. In our conversations with property managers we now enquire if they are happy that the reserves stated on the Balancing Statement are adequate but not excessive to meet future major expenditure.

Is VAT payable on service charges?
Ingram v Church Commissioners [2015] UKUT 0495 (LC)
This case considered if VAT is payable when the costs of staff employed by managing agents is passed onto lessees through the service charge. In this instance, the managing agents were employed by the landlord and the lease permitted the landlord to employ porters or such staff as considered necessary to meet the obligations under the lease. The managing agent charged VAT on these services and Janine Ingram challenged the VAT element claiming that it did not need to be paid and was therefore unreasonable.

VAT is always a complex tax and it is beyond the scope of the article to investigate the basis for the various arguments put forward in the case. However, the outcome of the dispute is of the utmost importance. The Upper Tribunal ruled that the managing agent was correct to charge VAT on employee salaries. The ruling is questionable and the circumstances surrounding the decision are considered to be largely unsatisfactory because HMRC were not asked to give their interpretation of the legislation at the Tribunal.

This uncertainty causes a real problem for the reporting accountant particularly in an audit situation when they are trying to form an opinion that the accounts are free from material error. This is very difficult to do when no one is entirely sure what the correct treatment is.

Another dispute is needed to test the position again and remove the uncertainty.

Can we recover company administration costs through the service charges?
Wilson v Lesley Place (RTM) Company Limited [2010] UKUT 342 (LC)
One of the most common circumstances we come across is directors of Residents’ Management Companies or Right To Manage Companies trying to recover company administration expenditure through the service charge. This is perhaps understandable given the inconvenience of separating out usually small amounts of company expenditure (e.g. statutory filing fees, Directors’ and Officers’ insurance) from service charge expenditure. However, the approach is not in accordance with best practice and is something we always try to resist at Haines Watts.

The case of Wilson v Lesley Place (RTM) Company Limited provides the legal backing for our position. In this case, the lease allowed administration costs to be recovered through the service charge. However, the court ruled that the administration costs were limited to the costs of managing the property or the estate. It did not extend to the administration costs of running the company and therefore these costs could not be recovered as part of the service charge.

As a reporting accountant it is always good to know that you can back up your position with a legal ruling.

When are costs “incurred”?
Moreshead Mansions Limited v Mactra Properties Limited [2013] EWHC 224 (Ch)
I do not have the same warm feeling for the ruling that emerged from the dispute between Moreshead Mansions and Mactra Properties. The case centred on the different interpretation of the term “incurred” by the legal and accounting professions. In the case, the lease mentioned the term “incurred” and the Judge ruled that costs are “incurred” when the obligation to pay arises. This is in effect cash accounting. Following on from this, the Judge further ruled that all that was required to meet the landlord’s obligation to provide accounts was a shopping list of expenses. No accruals, no balance sheet and no reserves were required.

For the reporting accountant this presents a real problem. The accruals concept is a fundamental accounting principle laid down in the Companies Acts, Accounting Standards, the 3rd RICS Code and best practice service charge accounting guide, TECH03/11. Accruals accounting states that costs should be matched with the period that the cost relates to.

The problem here is not whether the Judge’s interpretation is correct or incorrect. It is the failure to understand that if the reporting accountants do not have an accounting framework to rely on then it is impossible for them to carry out their role effectively.

A leading barrister, Amanda Gourley, described the judgement as “setting the legal cat among the accounting pigeons”. Either way, it left us all scratching our heads at Haines Watts.

Can I withhold payment of service charges because the audited accounts are not available?
Imperial Buildings Management Limited v John Nixon [2015] UKUT 0427 (LC)
This case is perhaps better known as The Elysian Fields case. It highlights the importance to all parties of ensuring that annual service charge accounts are prepared in accordance with the lease. The lease required service charge statements to be audited by an independent chartered accountant. The managing agent issued service charge demands without providing audited accounts. The lessee refused to pay the demands claiming that the landlord had failed to fulfil their obligations under the lease. A long, drawn out and costly dispute followed that concluded in the Upper Tribunal with the decision that the issuing of audited service charge accounts was not a condition precedent on the payment of service charges.

However, the ruling is not the only important issue arising from this case. The case shows how serious disputes can emerge between parties because of a failure to the follow the terms of the lease. It is a case we often refer to in our conversations with directors and property managers who would rather not follow the lease terms when it comes to certifying or auditing service charge expenditure.

Conclusion
Service charge disputes often impact on service charge accounts and therefore it is important that reporting accountants are up to date with legal rulings. This is only really possible if the firm of accountants reporting on service charge accounts are specialists, experienced and fully committed to the residential property management sector.

Haines Watts is a top twelve National firm of accountants with a dedicated team of accountants specialising in the audit and certification of service charge accounts. For more information about the team and the services they provide, please visit their website at hw-servicecharge.com.

 

March 2018