When do you need service charge accounts?

Published by Tim Levey on 18 July 2018

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Service charge accounts are usually required when a building is separated into individually owned and occupied units. This is because the building will need to settle shared costs (such as electric, water rates, repairs etc.) and therefore a formal summary of shared costs compared to the amounts demanded from the occupiers needs to be provided to account for any surplus or shortfall.

Service charge accounts are prepared for residential properties and commercial properties. The accounting requirements for each are different and require specialist knowledge and expertise in the leasehold sector. Below, we have split up the basic accounting requirements for residential properties and commercial properties.

Residential service charge (trust) accounts

The most common residential service charge accounting requirement is for a leasehold block of flats. The preparation of year-end service charge accounts requires careful consideration, particularly as the requirements of some leases are unclear and is often not understood that service charge funds are held under trust as a requirement of the Landlord & Tenant Act.

In 2011, specialist accounting guidance was published by a joint working group comprising representatives of the Institute of Chartered Accountants in England and Wales [ICAEW], the Association of Chartered Certified Accountants [ACCA], the Institute of Chartered Accountants of Scotland [ICAS], the Association of Residential Managing Agents [ARMA] and the Royal Institution of Chartered Surveyors [RICS]. This recommended guidance is for residential properties on which variable service charge are paid in accordance with a lease or tenancy agreement. Accordingly, ARMA registered managing agents should expect service charge accounts to be prepared in line with this guidance to help them fulfil their own reporting and compliance obligations to ARMA.

Residential Landlord Company statutory accounts

In addition to preparing the service charge accounts, the lease will set out the landlord which is often a limited company. Depending on the way the company has been set up, it may or may not have a legal interest in the property itself.

Often the company has been set up in the form of a Right to Manage (RTM) company which means that the leaseholders of the building have taken over the rights to manage the building in the future.

From an accounting perspective, the limited company will need to prepare accounts and submit them to Companies House each year. These are most commonly non-trading accounts, because the transactions that usually arise during a year relating to the collection of variable service charges under the terms of the lease which are trust monies. Trust monies do not belong to the company and under current best practice should not be recorded as an asset (and corresponding liability) in the company accounts.

In addition, if the company owns the freehold interest in the property then it may receive ground rents or other forms of taxable income (for example, lease extension income), plus there will be related costs. A net surplus will often result in a corporation tax liability.

The Limited company can be set up to hold either the freehold interest or to manage the property or both and it is important to understand the interaction with the property and the leases to ensure that the tax position is correctly identified and dealt with.

Commercial Property Service Charge accounts

The requirements for commercial service charge accounts are less onerous than for the residential sector. This is because commercial service charge accounting is not covered by any statutory guidance. However, there should be a lease that sets out the terms of sharing costs, and how those costs should be reported to lessees.

In 2014, specialist guidance was published by a working party of ICAEW commercial property specialist practitioners. The accounting framework applied in this guidance is that published by the Royal Institution of Chartered Surveyors (RICS) in the Third edition of its Code of Practice, Service Charges in Commercial Property (the Code) and has been developed by a working party of property industry bodies. Paragraph 4.2.5 of the Code states that annual statements of service charge expenditure should be reviewed by an independent accountant unless the cost of such a review would be disproportionate to the assurance obtained, for example in relation to smaller properties.

Mixed-use service charges

You may, of course, have a service charge that covers both residential and commercial service charges. This can be quite complex and we can advise on how these are dealt with.

If you would like to learn more, please feel free to contact Jo-Anne here, or call +44 (0)330 124 1399.

To view our specialist service charge webpage, please click here.

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