One of the more tricky issues for directors of Residents’ Management Companies (RMCs) to come to terms with is the distinction between cash raised through service charges and cash arising from the activities of the Company e.g. ground rent. The default option is to not distinguish between the two sources and to keep all cash received in one bank account held in the name of the Company. However, there are important distinctions between service charge funds and company funds and these differences have implications for RMC directors.
1. Service charge funds are trust funds
Service charge monies are deemed to be monies held in trust under section 42 of the Landlord and Tenant Act 1987. The Trustee will be the Landlord or the RMC if the Company has stepped into the place of the Landlord. Two important implications of this status are that,
- the use of the service charge money is restricted to meeting service charge expenditure permitted under the lease
- No benefit can arise to the Company from the money held under its control.
Monies raised from the activities of the Company, such as ground rents, belong to the Company. It follows from this that it might be easier to manage these two types of monies by holding the funds in separate bank accounts.
2. Accounting implications
Cash held in trust is not an asset of the Company and this causes a particular problem when preparing the statutory accounts of the RMC Company. One approach is to include all service charge transactions within the statutory accounts of the company and to include the service charge cash balance in the cash recorded on the Balance Sheet for the Company. This treatment is still permitted by the professional accountancy bodies and at first might be considered a more convenient and pragmatic approach.
The alternative treatment is to prepare two sets of accounts. One to record service charge transactions and a separate set of statutory accounts used to fulfil filing obligations at Companies House. These accounts will usually contain few transactions and the cash balance on the balance sheet will exclude any service charge funds.
Although both options are permitted, at Haines Watts we have no ambivalence on this issue. Separate service charge and statutory accounts should be prepared and the statutory accounts should not include service charge transactions and balances within them. This is the view of most professionals involved in the sector.
3. Using service charge funds to pay Company expenditure
If service charge funds and company funds are mixed together then this increases the likelihood of service charge funds being used to cover expenditure that is not permitted under the lease for the property.
Common examples are payments for Directors and Officers insurance and the administration costs for running the company (e.g. Annual Return fees). Using service charge funds to make these payments is probably not lawful and this treatment may result in RTM members being personally liable for these costs. The relevant legal case here is Wilson v Lesley Place (RTM) Company Limited [2010] UKUT 342 (LC). In this case, the Upper Tribunal concluded that the running costs of the RTM company were not recoverable as part of the service charge funds.
Conclusion
How do RMC directors convince lessees that it is necessary to prepare two sets of accounts and open two bank accounts in order for the Company to follow best practice? Often the mention of the words “Trust fund” causes lessees to glaze over and so an analogy along the following lines may help.
A company organises a Christmas collection fund for its employees. Each month, employees contribute to the fund with the intention that at Christmas the fund will be used to purchase Christmas hampers for employees at discounted rates. The company’s year-end is 30th November and at that date there is £5,000 in the Christmas fund. Should the company include the £5,000 Christmas fund balance on its Balance Sheet when the cash clearly does not belong to the company? How would employees feel if the Company used or borrowed the £5,000 to pay an unrelated supplier?
Written by Haines Watts
