Secret Hotels2 Ltd -v- HMRC: Court of Appeal

HMRC has won a significant victory in the Court of Appeal over the question of whether a travel agent operating through a website was acting as a principal or an agent in relation to the provision of hotel accommodation.

Secret Hotels2 (formerly MedHotels and referred to as such in the judgment) is a company in the LastMinute group specialising in Mediterranean and Caribbean holidays booked through its website, mainly by travel agents, but also direct by holidaymakers (together, "customers”).

The contractual provisions, both with the customers and with the hotel owners, specified that MedHotels was acting as agent for the hotel owners in providing accommodation to the customers. Accordingly, MedHotels considered that it was not acting as principal in providing travel services and so was not within the tour operators margin scheme (or TOMS). Consequently, it did not have to account for UK VAT. MedHotels' "margin" was actually the difference between the price paid by a customer and the amount it passed on to the relevant hotel owner. VAT was only payable by the hotel owner locally on that amount charged to MedHotels. The amount of the MedHotel "commission" was not divulged either to the customer or the hotel owner and was not brought within VAT at all.

HMRC argued that MedHotels was acting as a principal in providing travel services to the customers and therefore, under TOMS, it should have accounted for VAT in the UK (where it was established) on its margin.

The First Tier Tribunal (FTT) looked at the contractual arrangements between MedHotels, the hotel operators and the customers but also delved further into the way that MedHotels' booking process worked in practice and found that MedHotels acted as principal not agent. It considered in particular the fact that MedHotels kept deposits in its bank accounts rather than accounting for them immediately to the hotels, that it set its own commission and did not tell the hotel the quantum of that commission, and the fact that it paid compensation to customers, occasionally in the form of vouchers/discounts it issued and then recharged these to the hotels, rather than the hotels paying direct.

The Upper Tier Tribunal (UTT) disagreed and held that the contracts were clear - MedHotels was acting as agent. The contracts were not shams and so had legal effect; it had not been open to the FTT to look behind the contracts.

The Court of Appeal has now overturned the UTT's decision. Relying on Reed Personnel Services, Chadwick J held that the concept of a "supply" for VAT purposes was not identical to that of contractual obligation and so the FTT had been right to look at "the whole facts of the case" and go beyond the mere words of the contract. Having regard to the whole "package" of services supplied by MedHotels, Chadwick J held that the FTT was plainly entitled to conclude that MedHotels was doing more than supplying agency services to the hotels; it was itself supplying holidays. Accordingly, it was within TOMS and so should account for UK VAT on its margin.

This is a significant judgment because of the potential consequences for travel agents of being found to be acting as principals, not least the potential liability to customers for non-availability of, defects in or failures with the services provided. Given that the travel agent may also, through its website, provide other travel services such as car hire or flights, the cost to the travel agent for breach or for insuring against breach could be substantial. An appeal to the Supreme Court is anticipated.

Please click on the links below for the other articles in the February 2013 tax newsletter.

• HMRC publishes settlement opportunity
• HMRC -v- Charlton: FTT case on discovery assessments and possible defences
• Taylor Clark Leisure plc: VAT groups and repayment claims
• R (Prudential plc & another) -v- Special Commissioner of Income Tax: Supreme Court judgment on legal advice privilege
• HMRC -v- Anson: Court of Appeal rules on the tax transparency of Delaware LLCs
• VAT on acquisition costs following the Court of Appeal decision in BAA -v- HMRC
• UK FATCA regulations
• Proposed financial transaction tax