TOMS in distress

Kevin Hall and Priyam Sharma discuss the Upper Tribunal’s decision in CRC v Sonder and what the future holds for the tour operator margin scheme.

On 14 January 2025, the Upper Tribunal (UT) released its decision in the case of CRC v Sonder Europe Ltd [2025] UKUT 14 (TCC). It found in favour of HMRC, overturning the decision of the First-tier Tribunal (FTT). The UT decision exposes how the tour operator margin scheme (TOMS) legislation is not well formed. Clarity on the rules of TOMS is important for travel agents and for any supplier of accommodation, passenger transport, meals, events and so on.

In search of this clarity for the travel industry at large, and any other TOMS-suppliers, it is hoped that the taxpayer further appeals this decision.

Turbulence in TOMS

The UK VAT legislation was written to implement the requirements and meaning of the Principal VAT Directive 2006/112/EC (PVD). The UK legislation includes additional wording and HMRC applies this wording narrowly.

The question is whether the PVD had a wider meaning than HMRC is applying. This distinction is valuable for taxpayers who supply travel facilities but do not recover VAT on their purchases, such as exempt purchases (e.g. property rental) or overseas VAT which is too awkward or expensive to recover.

Such businesses, where excluded from TOMS by HMRC, are paying tax liabilities to HMRC on their full sales prices which might later be found to be significantly overstated if the PVD is later found to have a wider meaning than HMRC is applying.

Aim of TOMS

TOMS is a simplification measure. It creates a single place of supply in the country of the supplier’s relevant establishment and does not allow VAT on relevant purchases to be recovered.

This has two effects:

• The TOMS-supplier is not required to register for VAT in every jurisdiction where a travel service is provided; and
• The TOMS-supplier is not required to make awkward and expensive claims to recover input tax from the tax authority in every jurisdiction where a travel service is purchased.

Without TOMS, an internationally-operating TOMS-supplier (which most travel-related businesses are) would expect to register for VAT in every country where travel services are supplied (eg sleeping accommodation, passenger transport, meals, events, etc) or, if not required to register, would make a separate claim direct to each local tax authority where VAT had been paid on purchases.

It is therefore important to understand clearly the circumstances when TOMS applies to a supply chain and, if it does, which purchases can be deducted from the sales value. It is uncertainty in this mechanism which leads to expensive difficulties.

In this article we will review the legislation, the questions which arise and the decisions of the two tribunals.

Traversing the law on TOMS

To understand the decisions in Sonder, some background on the legislative framework of TOMS will be helpful. When interpreting the UK legislation, the UK tribunals and courts look to ‘construe the [UK legislation] in so far as possible to conform with the requirements of the [PVD]’ (paragraph 42, Sonder UT decision).

The PVD (see box Principal VAT Directive 2006/112/EC) requires the UK to apply a ‘special scheme’ – i.e. TOMS – to suppliers who ‘use supplies of goods and services provided by other taxable persons, in the provision of travel facilities’ (Article 306). The amount to be taxed is calculated as ‘the difference between the total amount, exclusive of VAT, to be paid by the traveller and the actual cost to the travel agent of supplies of goods or services provided by other taxable persons, where those transactions are for the direct benefit of the traveller’ (Article 308).

The UK legislation, see box The VAT (Tour Operators) Order 1987, applies different wording, but its meaning must lie within the scope of the PVD. The wording is similar at paragraph 3(1)(b), that the purchases be ‘supplied for the benefit of a traveller without material alteration or further processing’. This implements the PVD’s requirement that the purchases be ‘for the direct benefit of the traveller’ (Article 308).

The word ‘direct’ is changed in UK legislation to ‘without material alteration or further processing’. The question is whether the UK has restricted the meaning in the PVD, or whether this is what the PVD meant; or indeed whether the UK wording has a range of meanings and can be read in such a broad way that it conforms with the meaning in the PVD.

In trying to understand the single meaning of paragraph 3(1)(b) and Article 308, it is helpful to recall that the mechanism of TOMS is to ensure that what is purchased is for the direct benefit of the traveller, not for the direct benefit of the TOMS-supplier in making their supply. This became the point of contention in the Sonder case.

Sonder’s journey

Sonder purchased a lease of up to ten years in a property. It then provided the property to travellers as holiday accommodation.

In the terms of Article 306, Sonder must have considered that it ‘use[d] supplies of goods or services provided by other taxable persons… in providing travel facilities’. In the terms of Article 308, Sonder must then have calculated ‘the difference between the total amount… paid by the traveller and the actual cost to [Sonder] of supplies of… services provided by other taxable persons, where those transactions are for the direct benefit of the traveller.’ As the property lease was purchased for the direct benefit of the traveller, Sonder deducted it from the price paid by the traveller.

The FTT found that Sonder applied TOMS correctly, having purchased its interest in the property for the direct benefit of the traveller and having used this purchase in providing travel facilities to the traveller. Our article ‘Flawed approach to TOMS’ (Taxation, 21 August 2023) provides a brief summary.

HMRC appealed to the UT.

The UT found that Sonder had acquired a lease of up to ten years and that Sonder’s interest in land for a term of years was not for the direct benefit of the traveller, as it was materially altered or further processed into a short-term licence to the traveller to occupy property as holiday accommodation (paragraphs 100 to 114).

In reaching this judgment, the UT found in paragraph 85 that ‘the bought-in supply must be supplied for the direct benefit of travellers. In our judgment that is what the TOMS Order meant when it defined a designated travel service as a supply for the benefit of a traveller without material alteration or further processing’.

The UT criticised the FTT (in paragraphs 94, 98, 99, 100 and 113) on two points:

• For not determining the nature of the supplies both to and by the TOMS-supplier: ‘mischaracterised the precise nature of the supplies to which the test is to be applied’; and
• For not considering whether these supplies were materially
• altered or further processed.

The UT concluded that the supply purchased by Sonder had been subject to material alteration or further processing, on grounds including that the bundle of rights purchased by Sonder was different from the rights granted to the traveller (paragraph 114): the lease of years acquired, the repairs, the insurance, the furnishing by Sonder were all indications to the UT that the purchased lease was materially different or further processed before Sonder made its supply to a traveller.

In the UT’s words (paragraph 99): ‘The FTT ought to have been considering whether there was any material alteration or further processing of the term of years in an unfurnished apartment supplied by a landlord in circumstances where what was supplied to the traveller was a short term licence to occupy furnished holiday accommodation.’ To the UT, it was clear that what was purchased was materially altered or further processed and that TOMS did not apply.

Further questions

Taking a closer look at the legislation and its purpose, it is not clear that all the questions have been discussed or clarified. At the time of writing, the case might yet be appealed and much needed clarity might be brought to these issues.

In essence, it is not yet resolved whether the PVD had a wider meaning than HMRC is applying.

Ascertaining the meaning of the PVD (see box Principal VAT Directive 2006/112/EC) raises various issues to consider.

Broadly, these questions arise from the lack of definitions in the legislation.

• The PVD did not define ‘direct benefit’: what did it mean?
• What did the PVD envision in requiring that the TOMS supplier ‘use’ the purchases in making supplies of travel facilities?
• Is the meaning of the UK legislation’s wording restricted by the meaning of the PVD?
• What was the PVD trying to do in setting out rules for TOMS?

What is the purpose of TOMS?

It is worth recalling that the purpose of TOMS is to simplify administrative burdens for suppliers of travel-related supplies – preventing them from being required to register for VAT in other jurisdictions in order to account for output tax there and preventing them from having to recover input tax incurred in other jurisdictions.

For example, purchasing an interest in a property (e.g. holiday accommodation) will be a land-related supply and will be subject to VAT at the relevant rate in the country where the property is located. Similar location-specific VAT rules apply to passenger transport, meals, admission to events, and so on. A TOMS-supplier established in the UK will therefore incur VAT in every country where it purchases such supplies; and this input tax will either be recovered in a local VAT return or via an awkward and costly application to each overseas country’s tax authority. Protection from administrative burdens is needed for such purchases.

By contrast, other services purchased from those countries (such as a local professional services, supplies of staff, or local advertising) will be taxed under the ‘general rule’ and no VAT will be charged in those countries. Instead, the TOMS-supplier in the UK will apply the reverse charge. No protection is needed for such purchases.

Legislating the purpose: what does ‘use’ mean?

In providing that protection (ie TOMS), the PVD starts by considering the sale made by the TOMS-supplier and only then considers the purchases that go into providing that sale. In grammatical terms, the main clause of Article 306 refers ‘to transactions carried out by travel agents… in the provision of travel facilities’, adding a subordinate clause ‘who… use supplies of goods or services provided by other taxable persons’. Similarly, Article 308 starts with the sale before deducting the purchases which go into making that sale: ‘the difference between the total amount to be paid by the traveller and the actual cost to the travel agent of supplies of goods or services’.

This phrasing seems important: starting with the sale, and then limiting the application of TOMS to suppliers who ‘use’ purchases from other taxable persons. This seems to allow for purchases to be used partly to make the sale in question and partly to make other sales. It does not appear to suggest that

the purchase is necessarily used up, only that it is put to use in making the sale (i.e. providing travel facilities) for the direct benefit of the traveller.

Legislating the purpose: what does ‘direct benefit’ mean?

If one of the purposes of TOMS is to prevent suppliers from having to make input tax claims in other countries where purchases are subject to local VAT (such as property); and if that purpose is not concerned with other purchases which fall under the general rule (such as local professional services), how is this distinction made in the TOMS legislation?

The distinction is captured by the undefined term ‘for the direct benefit of the traveller’. Services which are subject to location-specific VAT such as holiday accommodation, meals, passenger transport, admission to events, etc. are supplies which, although purchased by a business and sold on, require an end consumer to benefit from them, i.e. to physically use them and enjoy them, such as occupying a room or travelling in an aircraft. The PVD refers to the purchases being ‘use[d]’ by the TOMS-supplier in providing travel facilities. It cannot mean ‘use[d]’ by the TOMS-supplier in the sense of occupying a room or travelling in an aircraft; rather the legislation appears to require that ‘use’ is made of whatever is purchased in providing travel facilities as a single supply for a traveller to benefit from them, i.e. to physically use them and enjoy them, such as by occupying a room or being transported.

Again, the question arises whether the PVD’s wording leaves room for a purchase to be ‘use[d]’ only partly by the TOMS-supplier in providing travel facilities to each specific traveller, so long as that part of the purchase is for the direct benefit of that particular traveller.

Legislating the purpose: application

The purchase of a longer interest in property, which the TOMS supplier maintains and insures, does not appear to prevent the TOMS-supplier from making use of their purchase in providing travel facilities for travellers to occupy. In that sense, the traveller benefits directly from the use made by the TOMS supplier of their acquisition of an interest in the property, and this description appears to fall with the PVD.

The bundle of legal rights purchased and the bundle of legal right supplied on might indeed be different (Sonder UT), but is the supply chain nevertheless in conformity with the purposes of TOMS and with the PVD expression of that purpose?

Legislating the purpose: UK legislation

The issue of what the PVD meant (and therefore what the UK legislation means) also leads us to question why the UK legislation states ‘supplied for… a traveller’ when the PVD states ‘provided for … the traveller’ (our italics).

The UT in Sonder focused on characterising the legal nature of the ‘supplies’ to and by Sonder. The question arises whether the different emphasis in the PVD perhaps suggests that ‘supplies’ in the UK legislation is not the important word in determining the meaning of the TOMS rules.

For example, a different consideration is whether an apartment is provided to a traveller for occupation by the traveller (i.e. for their direct benefit), where an interest in that apartment had been previously acquired by a tour operator and the interest in that apartment was used by the tour operator in providing that apartment to the traveller as a component of the travel facilities. This description appears to be within the scope of the PVD wording, therefore requiring that TOMS applies, irrespective of the length of interest acquired in the apartment.

The UT in Sonder said that such purchases do not qualify, which creates some difficulty for a business when reading the UK legislation in conformity with the purpose and meaning of the PVD. Despite the findings of the UT, the nagging question remains whether the UK legislation’s term ‘without material alteration or further processing’ emphasises the intensifier ‘material’ in the way the FTT did?

It is not clear whether the FTT approach or the UT approach better reflects the meaning and purpose of the PVD. For example, if a tour operator hires a coach without a driver to transport travellers from an airport to a hotel as part of a ‘package deal’, should TOMS apply? What if the coach is hired with a driver? The UT decision suggests that, as the hire and use of a whole coach (even with driver) is a different bundle of legal rights to the supply of a single seat to transport a traveller, TOMS does not apply and the tour operator is required to register for (and charge) VAT in the country where the passenger transport takes place, but is required to apply TOMS to all other aspects or the travel package. Is this fulfilling the purpose of TOMS?

Conclusion

The UT has decided that TOMS applies only narrowly, comparing the bundle of rights supplied to the TOMS supplier and the bundle of rights supplied by them in order to determine whether there is a material difference or further processing.

However, there is a significant tension at the heart of TOMS, resulting from undefined terms in the PVD and UK legislation, i.e. ‘use’, ‘direct benefit’, ‘material alteration or further processing’, ‘provided/supplied’. This yields practical considerations and the sense is that some questions are left unanswered. Is it right that the hire of a single coach (with driver) is not ‘for the direct benefit of the traveller’ simply because a purchase ‘in bulk’ is a different bundle of rights to those rights received by each individual traveller? Must every TOMS-supplier register for VAT in every country where it hires a whole coach or acquires a longer interest in accommodation?

It is hoped that this case is appealed further, in order to obtain the highest judicial authority. Until then, all taxpayers making travel-related supplies should consider whether to make protective claims in case this decision is ultimately decided in the taxpayer’s favour.

There might be a long way to ‘travel’ before reaching clarity on TOMS.

This article was originally published in Taxation magazine in February 2025.

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