The UK Court of Appeal has given a significant judgment on the question of whether an online travel agent is acting as a principal or an agent in relation to liability for VAT on the provision of hotel accommodation.

The court has handed a significant victory to HMRC, the UK tax authority, against Secret Hotels2 (formerly MedHotels), overturning the decision of the Upper Tribunal (High Court). The court found MedHotels liable for VAT under the Tour Operators Margin Scheme (TOMS) on the grounds that it operated as a principal, supplying travel services in its own name, and not as an agent. MedHotels is now owned by Thomas Cook, but its former owners,, are liable for the £7 million tax obligation which dates from 2004 to 2007. The decision has not been further appealed.

MedHotels specialised in Mediterranean and Caribbean holidays booked through its website by third-party travel agents or customers. The contractual provisions stated that MedHotels was acting as an agent for the hotel operators in providing accommodation to customers. The hotel operators would therefore be acting as principal and would be responsible for VAT payments in the country where the hotel is located. MedHotels would not be liable for UK VAT.

HMRC argued that by looking at the entirety of the commercial arrangements and the accounting procedures adopted, MedHotels was in fact acting as principal. This would mean that VAT was due on the income received by MedHotels as if it were a retailer, rather than its revenue stream being the commission in respect of services provided to the hotels.

In 2010, the First Tier Tribunal (FTT) looked at the contractual arrangements between MedHotels, the hotel operators and the customers but also looked at the way the companies behaved in practice. It found that MedHotels was in fact acting as a principal not an agent. A ‘shopping list’ was given of factors that were not consistent with agency, in particular, the facts that MedHotels: set its own commission and did not disclose it to the hotel; dealt with holidaymakers in its own name and kept its own handling agents at the hotels; kept deposits in its own bank accounts rather than accounting for them immediately to the hotels; and made compensation payments to customers and then recharged these to the hotels, rather than the hotels paying direct.

The Upper Tier Tribunal (UTT) reversed the decision a year later. The contractual language as to agency was clear. The contracts were not shams and as such the FTT did not need to look behind them.

The Court of Appeal overturned the UTT and agreed with the FTT that there was a need to have regard to “the whole facts of the case” and look behind the contracts. In deciding that MedHotels was not acting as an agent and not a principal, the Court agreed with the FTT that, in looking at the entirety of the commercial arrangements, MedHotels was itself supplying holidays. It is not enough to call yourself an agent; you must act as an agent too.

Although this is a tax case, it has the potential to have a far-reaching impact on the travel industry. If online travel agents are suppliers of services, they will face exposure for any failure to provide the hotel accommodation properly. Hotel operators will also be at risk if the distribution model that they think has been agreed with the online travel agent is in fact found not to reflect the commercial reality – there is a particular risk under competition law, which takes broadly the same approach to assessing agency relationships. Practically, hotel operators should carefully review their agreements with online travel agents and should ensure that the relationship between travel agents and holidaymakers reflects the relationship that has been agreed higher up the chain.

ABTA has issued guidance in the wake of the decision ("Agent or Principal: How does your business trade?") which is available on the Member area of its website, reinforcing the importance of the need for all travel companies to understand their status when buying and selling services.

(Secret Hotels2 Ltd (formerly Medhotels) [2012] EWCA Civ 157)