Here is the thing most guidance on residential service charges gets wrong: there is no statutory requirement to prepare annual service charge accounts at all, and no statutory audit requirement. The duty to account comes from the lease. What statute adds is a tenant's right to request a summary, an 18-month time limit on demanding costs, and a trust over the money.
Where the obligation actually comes from
The lease is the contract for the administration of service charges, and it is the lease that says what has to be produced, in what form, and by when. The professional guidance is explicit that there is no statutory requirement for the routine preparation and content of service charge accounts — but that the accounts should comply with the lease, because otherwise there may be difficulty recovering the expenditure.
That is the commercial point. Non-compliance with the lease is not a regulatory problem; it is a recoverability problem.
The three statutory provisions that do bite
Section 20B, Landlord and Tenant Act 1985 — the 18-month rule. If relevant costs were incurred more than 18 months before a demand for payment is served, the tenant is not liable for so much of the charge as reflects those costs. The escape is in subsection (2): the limit does not apply if, within 18 months of the costs being incurred, the tenant was notified in writing that the costs had been incurred and that they would subsequently be required to contribute.
That notification is the single most valuable administrative habit in this area. A managing agent who issues a section 20B notice as a matter of routine preserves recoverability on costs that would otherwise be lost to a slow billing cycle.
Section 21 — the right to a summary. A tenant may require the landlord in writing to supply a written summary of relevant costs. The landlord must comply within one month of the request, or within six months of the end of the accounting period, whichever is later. Where charges are payable by the tenants of more than four dwellings, the summary must be certified by a qualified accountant as a fair summary, sufficiently supported by accounts, receipts and other documents produced to them.
A significant caveat that a great deal of published commentary ignores. The Commonhold and Leasehold Reform Act 2002 was to replace section 21 with a regime of regular statements of account and accountant's reports. That substitution was brought into force only so far as it confers power to make regulations — and the power has never been exercised. The same is true of the later Housing and Regeneration Act 2008 substitution. So the "regular statements of account" regime has never come into force, and the 1996 version of section 21 is the one that applies.
Section 22 — inspection. A tenant who has obtained a summary may, within six months, require reasonable facilities to inspect the supporting accounts, receipts and documents and to take copies. Inspection is free of charge, though a reasonable fee may be charged for copies, and the facilities must be available for two months beginning no later than one month after the request. This section remains in force.
The money is held on trust
Section 42 of the Landlord and Tenant Act 1987 puts service charge contributions on statutory trust. Sums paid by contributing tenants, and any investments representing them together with income, are held by the payee as a single fund or in separate funds — on trust to defray the costs for which the charges were payable, and subject to that, on trust for the contributing tenants for the time being.
Two consequences follow, and both are regularly breached:
- Ring-fenced accounts. Service charge monies are trust monies and should be held in designated bank accounts. A separate account per scheme is not required unless the lease says so, but the funds for each property must be separately identifiable — it is a breach of trust to use one property's service charge money to pay another's bills, or the landlord's;
- Not the company's asset. For a residents' management company or RTM company, trust monies do not belong to the company and should not appear as an asset in its statutory accounts. The service charge statement is a separate document from the accounts filed at Companies House.
Audit, or a report of factual findings?
This is where fees and expectations diverge, and the answer turns on the lease.
If the lease refers to an audit, then in principle an audit should be carried out. Where a lease drawn up since 1980 requires an audit, that is what should be done — procuring some other form of examination could be challenged by a lessee, and a tribunal might refuse recovery of the charges on that basis. Where an audit is required, ISA 800 on special purpose frameworks provides the framework.
For older leases there is room to argue. The term "audit" in a pre-1980 lease would not have involved particular procedures beyond those needed to help prepare the accounts — whereas for a practising accountant to state today that an audit has been undertaken requires compliance with generally accepted auditing standards.
Where the lease is silent on the form of examination, the normal arrangement is a report of factual findings rather than an audit, though there may be circumstances where an audit is appropriate.
And a cost point worth raising with clients: if an audit is carried out when the lease does not require one, the extra cost over a report of factual findings might not be recoverable through the service charge. Doing more than the lease requires can be a cost the landlord bears personally.
On who may report: the reporting accountant need not be a registered auditor, but must hold a practising certificate, comply with professional indemnity requirements, and be independent of the landlord and managing agent. The exception is the section 21 certification, which the professional guidance states must be made by a registered auditor.
Form, timing and the guidance's own vintage
There is no recognised accounting framework for a service charge statement, and the section 21 content requirements do not amount to accruals accounting or require a balance sheet. The professional guidance nonetheless recommends the accruals basis, with a balance sheet for the service charge fund, an income and expenditure account and explanatory notes — unless the lease requires a cash basis. Comparatives are not required. A related party note is good practice.
On timing, best practice is to issue the statement within six months of the year end, driven by the section 20B and section 21 deadlines rather than by any rule of its own.
Be candid about the source, though. The governing technical release, TECH 03/11, states the law as at 1 October 2011 and carries its own warning on the title page that it has not been updated since release and that references to external material are out of date — users should construe it against current auditing and accounting standards. It remains the operative guidance, issued jointly by ICAEW, ACCA, ICAS, ARMA and RICS. It is simply old.
Reform is also pending. The Leasehold and Freehold Reform Act 2024 amends sections 20B, 21 and 22, with new sections 21C to 21H to be inserted — none of it in force, and no commencement date established.
Tax and VAT
Where the section 42 trusts apply unmodified, HMRC's view is that receipt of service charge payments subject to those trusts gives rise to no tax liability in the payee's hands, so long as the trust terms are observed. Investment income on the fund — normally bank interest — is chargeable at the standard rate of income tax. Ground rent belonging to a management company sits outside the trust and within corporation tax.
On VAT, service charges for the upkeep of common areas of dwellings are normally exempt as further consideration for the exempt supply of accommodation, so the landlord cannot recover input VAT on the underlying costs — while a managing agent's fee carries VAT as a taxable supply to the landlord. Our guide to VAT on service charges works through that split.
Acumon prepares and reports on residential service charge accounts through flat management accounts and statutory accounts work, with property VAT advice where the recovery position matters. If your leases require an audit and you have been providing a report of factual findings — or the reverse — that mismatch is worth resolving before a lessee raises it.