In recent years, an industry has grown up around businesses that buy in residential accommodation for long periods and then rent it out to travellers, often through platforms such as Airbnb or Booking.com. The rentals typically range from one or two nights up to about a month. This model has proved to be a popular alternative to hotel accommodation as it provides kitchen facilities, allowing travellers to prepare their own meals rather than being restricted to eating out, which can be expensive. Having more space is also attractive to both family groups and business travellers.

However, a key issue has arisen concerning the VAT treatment of such serviced accommodation, also known as rent-to-rent. Hotel rooms are standard-rated in the UK, with a reduced rate of VAT applying from the 29th day onwards. Holiday accommodation is also standard-rated. If serviced accommodation providers could avoid having to charge VAT at 20% then they could be more attractive than hotels and other forms of holiday accommodation.

The Tour Operators’ Margin Scheme

Generally, the sector has applied the Tour Operators’ Margin Scheme (TOMS) to its supplies. TOMS was originally an EU scheme that seeks to ensure that tour operators do not have to register and account for VAT in the countries where they send travellers. Post-Brexit, a UK-specific version of TOMS is used in the UK. 

Under TOMS, a business that buys in and resells certain travel services on a business-to-consumer (B2C) basis without material alteration, and as principal, must account for VAT on the margin only, rather than on the full value of the supply. Input tax cannot be claimed on the bought-in travel services. The margin is standard-rated if the travel services are enjoyed in the UK and zero-rated if they are enjoyed outside the UK. The services that qualify are:

• accommodation;
• passenger transport;
• use of means of transport (eg, car hire);
• airport lounges;
• trips or excursions; and
• services of tour guides.

Serviced accommodation providers do not incur VAT on the purchase of the accommodation because they take out residential leases, which are exempt from VAT. Thus, there is no irrecoverable VAT incurred. This results in a VAT saving compared with what would be payable under the normal rules.

The case of Sonder Europe Ltd

Along with other serviced accommodation providers, Sonder Europe Ltd (Sonder) used TOMS to pay VAT only on its margin. However, HMRC disagreed and raised assessments for VAT using the normal rules, meaning VAT was due on the full amount received from the customer. 

Sonder appealed successfully to the First-tier Tribunal (FTT) (Sonder Europe Ltd v HMRC [2023] UKFTT 00610 (TC)). HMRC appealed to the Upper Tribunal (UT) and, in a decision published on 15 January 2025, the UT found in favour of HMRC (HMRC v Sonder Europe Ltd [2025] UKUT 00014). This means that VAT must be accounted for on the total income received for rent-to-rent holiday accommodation, rather than just the margin. UT decisions are binding and set a legal precedent, meaning they must be followed unless HMRC issues guidance to the contrary.

The facts

TOMS applies to a “designated travel service”, which the UK regulations define as “supplied for the benefit of a traveller without material alteration or further processing”, while the EU directive (applicable to the period covered by the appeal) uses the term “for the direct benefit of the traveller”.

Sonder leased apartments on a long-term basis (generally 2-10 years). No VAT was charged to Sonder on the leases as it was residential accommodation. Sonder furnished and decorated some of the apartments, but some of the apartments were already furnished by the landlords. Sonder then let the apartments out as short-term accommodation for periods of between one night and one month.

Sonder accounted for VAT on its margin, arguing that the supplies fell within TOMS as the accommodation was bought in and sold on without material alteration. HMRC contended that TOMS did not apply, and that VAT was due on the total income received.

FTT’s findings

The FTT focused on the physical alterations made to the apartments. It found that there was no material alteration, as any alterations made were easily reversible. The addition of furniture, repairing damage, or decorating did not constitute material alteration. HMRC had argued that material alteration had occurred, so that what was rented in was not the same as what was rented out. However, it is worth noting that Sonder spent a relatively small amount on maintenance and repairs – £20,000, compared with £1.5m paid in rents to landlords. 

The FTT decided that the apartments themselves were not materially altered despite their tax status changing from exempt land for residential occupation to holiday accommodation. The tribunal stated that material alteration “must refer to more than minor changes or processes which do not affect the fundamental character of the particular goods or services”. The FTT also noted that changes that can be reversed, such as painting a wall or removing furniture, do not constitute material alteration or processing.

It held, therefore, that TOMS applied to the supply and Sonder could account for VAT only on the margin. 

UT’s findings

The UT found that the FTT had erred in the test that it applied and that the correct test to be applied should be that “the scheme will apply where there has not been a material alteration or further processing of the bought-in supply such that what is bought in is not supplied for the direct benefit of the traveller”. 

The UT then determined that, considering the facts as a whole, there was a bundle of rights supplied to Sonder that was substantially different to the bundle of rights supplied by Sonder to its guests. The UT gave particular weight to the fact that Sonder entered into internal repairing and insuring leases for a term of years, but that what was supplied to the guests was a licence to occupy holiday accommodation for a short duration, with guests simply required to provide credit card details against which a charge could be made in the event of any damage caused.

There was therefore a material alteration to the supply, and the original supply could not have been supplied for the direct benefit of the guest. In the words of the UT: “Sonder was therefore acquiring rights in land from which it could then make its own in-house supplies.”

What do businesses need to do now

Sonder has applied for permission to appeal to the Court of Appeal and we should hear within a month whether permission is granted. If it is, the hearing may not take place for another year or so with a decision within a further six months or so. If permission is not granted then the case is complete. HMRC has so far not issued any guidance about what businesses in Sonder’s position should do.

In the meantime, businesses that operate in a similar way to Sonder need to implement the Sonder decision by not using TOMS but instead using the normal rules to calculate VAT payable from a current period. VAT at 20% must be declared on lets of 28 days or less. VAT at the reduced rate (usually taken to be 4%) may be applicable from the 29th day of longer stays. The application of this rule is very sensitive to the facts of individual cases so please take advice if you think this may apply. Smaller businesses with a turnover of £150,000 or less might be able to use the flat rate scheme.

Going forward, if Sonder continues its appeal, businesses may wish to consider submitting regular error corrections to HMRC to claim the difference between VAT paid under normal rules and VAT due under TOMS. Although HMRC is likely to refuse these claims, businesses can then submit an appeal and stand behind the Sonder case. Submitting error corrections in this way will protect against any periods dropping out of time for claims, should Sonder win their case in the future.

In relation to the past, where businesses submitted an error correction on the basis that they were now applying TOMS, and the error correction was paid, HMRC has two years from the date of payment to claw back the payment. The Sonder decision is not considered a ‘new fact’, so HMRC does not have a new 12-month period from the date of the decision to claw back payments made. 

Businesses may be able to rely on a defence of legitimate expectation to support not having to rework VAT returns using normal VAT rules for the past four years. They would have to argue that they submitted VAT returns in the past four years in line with HMRC’s acceptance of their error correction, which led the businesses to believe they were acting correctly. Similarly, where a business has had a VAT inspection by HMRC in the past and HMRC accepted the use of TOMS, such businesses may also be able to claim legitimate expectation.

However, it is difficult to win an argument based on legitimate expectation. This is a very complex area, and we recommend taking advice if a business is in this situation.

Where a business has applied TOMS but not had an inspection, and also did not make a repayment claim under TOMS that was paid by HMRC, the business has made errors on its VAT returns by applying TOMS. It is their responsibility to correct the past four years’ VAT returns by applying normal VAT rules and submitting an error correction to HMRC. Alternatively, businesses can write to HMRC to notify them that TOMS has been used, providing details of VAT amounts underpaid by period.

This may change if HMRC decides to issue guidance to businesses that have been applying TOMS. For example, if leave to appeal is given to Sonder, HMRC could allow such businesses to continue using TOMS until the Court of Appeal decision is known.

Businesses should also consider whether they can distinguish their own position from that of Sonder’s.

Conclusion

This is a huge change for serviced accommodation businesses and margins are low in the sector. Having to pay VAT on the whole amount paid will probably remove the advantage that serviced accommodation has over traditional hotels. Will travellers be willing to pay more for serviced accommodation? If providers cannot pass the VAT on to consumers, then we are likely to see providers leaving the sector or even going under. There will be a knock-on effect on property owners who lease their properties on long-term leases to the providers as they will be left with empty properties. Agents such as Airbnb and Booking.com will also be impacted. There could be huge changes ahead for this sector.

Sue Rathmell, VAT Partner, MHA.