Where a landlord makes an additional charge to tenants for the upkeep of the structure and common areas of the property, that service charge is normally treated as part of his main supply of accommodation.
Therefore, if the rent is exempt (e.g. for residential property) so is the service charge.
A recent ECJ case, RLRE Tellmer (C-572/07), has brought this into question although the outcome will not mean much change to UK policy. The issue was whether cleaning of the common parts of an apartment building was exempt from VAT as was the rent.
The ECJ decided that, based on the facts available (and they were limited), the cleaning service was a separate supply and thus standard rated. However, this should not strike fear into UK landlords, in particular registered social landlords (e.g. housing associations) because there are aspects to the case distinguishable from normal UK rent agreements and an encouraging statement of policy from HMRC.
It would appear that in the Tellmer case, the tenant was not required to obtain the cleaning services from the landlord, whereas one condition of the UK treatment is that service charges follow the treatment of the rent where the tenant must receive them from the landlord.
As a result of this case, HMRC say that service charges will take their normal VAT treatment (e.g. standard rated for cleaning services) only if: there is a requirement for service charges to be paid, but either the services are either provided by a third party or they do not arise as a condition under the lease agreement
But even then, under certain circumstances, the services can still be treated as exempt by concession (ESC 3.18).
Most UK landlord/tenant agreements require the tenant to obtain services for the upkeep of the structure and common areas from the landlord and will not be affected by this case.
However, landlords or tenants involved with agreements where there is an option should be aware that it is not automatic for service charges to follow the VAT treatment of the rent.
Ultimately, if service charges are exempt, landlords will pass on the VAT-inclusive cost of services (e.g. standard rated cleaning services bought in from a cleaning contractor) to their tenants, so there should be no real cost to them whether or not service charges should be standard rated.
However, the risk of unwanted assessments, interest and penalties should be enough to encourage them to understand and apply these principles correctly.