Charities, VAT, and the skeletons in the closet: Why regular VAT reviews are essential for charities

Skeletons in the closet 

As the echoes of Halloween fade and the last of the autumn decorations are packed away, it’s a good time to consider what ‘skeletons’ might be lurking in your charity’s financial closet, particularly when it comes to Value Added Tax (VAT). For many charity finance managers, VAT can be a daunting area, full of hidden risks and surprises. The complexity of VAT for charities means that what’s out of sight can quickly become a costly problem. Regular reviews of your VAT systems are not just good practice, they’re vital to ensure you aren’t haunted by past mistakes or missed opportunities.

Why review your VAT system now? 

Even if your charity’s VAT processes seem to be working smoothly, outdated systems can harbour risks that only come to light when it’s too late. Changes in charity activities, income streams, or even shifts in VAT law can all create ‘skeletons’, issues that, if left unchecked, may result in underpaid tax, penalties, or lost reliefs. The impact of staff turnover is particularly significant; when finance personnel change, crucial knowledge can be lost, and assumptions about VAT treatment can go unchallenged. A fresh review provides an opportunity to update your approach and catch any emerging risks before they become real problems.

Income treatment: Grants, contracts, and evolving definitions 

One of the trickiest areas for charities is the treatment of income. The line between a grant and a contract for services is not always clear, and how they are defined has been evolving. Grants are outside the scope of VAT, but if they are in fact contracts for services, they will be taxable or exempt depending on the nature of what’s being provided. Misclassifying your income can have serious repercussions, not only for your VAT liability but also for your ability to recover VAT on associated costs. With funders and regulators updating their requirements, in agreement drafted more carefully than ever, it’s essential to revisit your income streams and ensure all your grant agreements are being treated appropriately.

VAT treatment choices: Exempt, outside the scope, zero-rated 

Charities face a range of choices in how they treat income for VAT purposes. Some income may be exempt (such as qualifying welfare or fundraising activities), some outside the scope (like pure donations or grants), and some may qualify for zero-rating, or may be standard rated of course. Importantly, the more exempt income you have, the less VAT you may be able to recover on your expenditure. Equally, the more zero-rated income you can identify the better because, unlike exemption, zero-rated income is ‘taxable’ income and so allows for related VAT on expenses to be recovered from HMRC. Getting the categorisation right is crucial. Mistakes such as missing standard rated income or coding income as zero-rated when in fact it is exempt or vice versa, can lead to overpaying VAT or facing a nasty surprise if HMRC reviews your system. In our experience of working with charities over the years there are always errors to be corrected and more often than not a charity’s overall VAT cost can be reduced with specialist help.

VAT recovery: Methodologies and their implications 

How you categorise your income directly affects your VAT recovery. Charities must use appropriate methodologies to determine how much VAT they can reclaim and adopting the most appropriate one for your charity requires specific consideration. This might involve agreeing something other than your standard, income based, partial exemption method with HMRC, i.e. a partial exemption special method based on alternative criteria, or some ingenuity when it comes to devising a suitable business/non-business method. As your charity evolves—taking on new projects, income streams, or funding mechanisms—it’s wise to review whether your current methodology is still fit for purpose. An outdated or inappropriate recovery method could mean you’re missing out on VAT you could legitimately reclaim, or, conversely, reclaiming too much and risking penalties.

Property works: VAT implications and opportunities 

Property-related expenditure is another area where VAT can be particularly complex for charities. Building works, refurbishments, or new developments often involve significant sums and the VAT treatment isn’t always straightforward. There are often property works that qualify for the reduced or zero VAT rates, especially if they relate to relevant charitable or residential use, disabled access, or qualify as residential conversions. However, the rules are intricate and easy to misinterpret. A regular, or even ‘per-project’, review of your property developments can help ensure you’re maximising available reliefs or the recovery of VAT charges and not missing out on valuable opportunities to reduce VAT costs. Failing to get it right can have long-term financial consequences, especially as the VAT incurred on larger property developments may need to be reviewed and adjusted for ten years following completion.

Maximising legislative reliefs 

There are a range of legislative reliefs available to charities, from zero-rating certain property works as mentioned above, to advertising and fundraising, or to reliefs on medical equipment. However, these reliefs are only effective if you’re aware of them and apply them correctly. Again, regular VAT reviews provide a chance to ensure your charity is making full use of all available reliefs, keeping more funds available for your charitable aims. 

Conclusion: The need for ongoing vigilance

VAT is a notoriously complex area for charities, filled with potential pitfalls and opportunities alike. As the post-Halloween dust settles, now is the perfect time to open the closet and check for any VAT ‘skeletons’ that might be hiding. Proactive, regular reviews of your VAT systems covering income treatment, recovery methodologies, property works, and legislative reliefs are essential for avoiding costly mistakes and keeping your charity in good financial health. Don’t let hidden risks haunt your organisation; make VAT vigilance a regular part of your financial management.

If you would like assistance reviewing your VAT systems, please do not hesitate to get in touch.