Key Elements of Hotel Management Agreements (HMA) – „Key Money” 

Spread the love

Competition among branded hotel operators to secure long-term management contracts can be fierce. Savvy hotel owners and developers often engage in competitive bidding processes, evaluating not only brand recognition, reputation and quality, but also the financial incentives offered by operators. Key money can have specific tax implications, particularly with respect to value added tax (VAT). 

Economic nature of key money 

Key money is a financial incentive commonly used in the hotel market where: 

  • the operator transfers funds to the hotel owner in exchange for a long-term management contract, or  
  • The hotel owner transfers funds to the operator as an incentive to enter into a management contract.   

The funds are usually disbursed at the time of the hotel opening or shortly before or after the opening. 

In most cases, key money is non-refundable unless the management contract is terminated before the end of the term or other conditions are met.  

The amount of key money depends on various factors, such as the size and location of the hotel, the projected fees during the term of the management agreement and the competition for hotel management services from other operators. A hotel of strategic value to the brand, such as a hotel located in a prestigious property in a key location in a major city, may require the payment of a significant amount of key money.   

Legal Nature of Key Money 

Key money can be based on various civil law constructions. In particular, it may take the form of a guarantee or other security for the performance of a contract. In many cases, it can and does take the form of an undisclosed contract for civil law purposes. Key money can also be paid in different ways, depending on the individual arrangements between the hotel owner and the hotel operator. It can be paid as a lump sum, in installments, added to the rent, or in any other form agreed upon according to the needs of both parties. 

Taxation of Key Money 

Key money can be a type of financial incentive paid by the operator to the property owner in order to secure a management contract and prevent the conclusion of such a contract with a competitor.   

For VAT purposes, it is important to determine whether the payment of key money should be classified as 

  • a consideration for a service,   
  • and, if so, whether, in light of the provisions of Article 28e of the Act, it should be classified as the consideration for service related to real estate and, therefore, subject to VATthat real estate is located.   

Payment of Key Money as Payment for a Service for VAT Purposes 

In principle, any supply that does not constitute a supply of goods is a service for VAT purposes (Article 8 of the VAT Act).   

Considering that the subject of the supply for which the key money is to be paid is not a supply of goods (not applicable to goods or energy), this service will constitute a service within the meaning of the VAT regulations.   

In principle, the supply of services for consideration is subject to VAT. In the case of key money, it constitutes remuneration for the service in question. This service may therefore be subject to VAT. 

Category of services 

For VAT purposes, a service can be either autonomous or complex. In the case of the complex service, the constituent elements are not an end in themselves and share the fate of the main service. In other words, complex services are characterized by the fact that their constituent elements, although separable, form an inseparable whole that cannot be considered separately for VAT purposes. This means that the payment of key money may be subject to the same taxation rules as the entirety of the services under the contract.  

If the key money payment is not closely linked to other services, i.e. the payment does not lead to the provision of the main service, it may be considered as a separate service. In this case, the recipient of the payment receives funds for a specific obligation that is independent of other activities.  

The situation is quite different when the key money is part of a broader package of services. If the payment is inseparable from other services, it may be necessary to consider it as part of a comprehensive service. 

Payment of key money as remuneration for a property-related service   

For VAT it is important to determine the category of service to which the key money relates, which may determine the relevant place of supply, the VAT rate or other elements affecting the final amount of tax liability. In particular, it is important to determine whether the key money constitutes remuneration for a service related to the property, as referred to in Article 28e of the VAT Act.   

The VAT Act does not define the term „service related to real estate”. It is regulated by the Implementing Regulation of the Council of the European Union No. 282/2011 of March 15, 2011 laying down implementing measures for Directive 2006/112/EC on the common system of value added tax (recast) (OJ L 77, 23.03.2011, p. 1-22.). According to Article 31a(1) of the aforementioned Implementing Regulation, 'services connected with immovable property’ means services which have a sufficiently direct connection with the immovable property concerned. Services are considered to have a sufficiently direct connection with the immovable property in the following cases  

  • When they originate from the immovable property and the immovable property in question is an integral part of the service and is central and indispensable to the services provided.  
  • when they are provided in relation to the immovable property or are intended for the immovable property and are intended to alter the legal or physical condition of the immovable property.  

Therefore, in order to classify a particular service as „real estate related”, it is crucial to determine whether the service is closely and inextricably linked to a specific real estate, regardless of the entity for which it is provided and the location of the service provider. 

In Poland, considering that the use of incentives such as key money is quite an innovative solution , there is no interpretation of the regulations that explicitly refers to this solution. Therefore, each case should be analyzed individually and in detail.  

An argument in favor of the qualification of the service that key money is related to real estate for VAT purposes is the connection of the payment in question to a specific property, without which the operator would not be interested in concluding and securing the conclusion of a management contract. On the other hand, there may be doubts as to whether these services are really aimed at changing the legal or actual status of the property.  

For example, the payment of key money may be considered an advance payment if it is related to future services to be provided by the hotel operator to the property owner. An example would be funding the implementation of a management system, the commencement of operations or the branding of a hotel.  

Another approach is to treat key money as a discount granted by the property owner to the hotel operator. This qualification may be justified when key money acts as a financial incentive, for example, to reduce the costs associated with taking over the management of the property. 

Summary  

Proper VAT treatment of key money  is crucial, both from the perspective of properly drafting the provisions regarding this form of incentive in the contract between the operator and the property owner, as well as from the perspective of properly documenting and taxing them. Addressing these issues in detail will help avoid potential tax disputes and ensure compliance with applicable regulations, which is particularly important in the context of increasingly complex commercial real estate transactions.