Is your charity planning significant building works?
Your foremost financial consideration should be VAT…
VAT is ever so complicated. We are fortunate to have some very experienced charity VAT specialists who explain issues clearly and arrive at sensible solutions to mitigate exposures.
An area which needs careful consideration is charity property development. It is important because whilst there are solutions to reduce the VAT burden the expenditure is significant and so, therefore, are the pitfalls which can catch charities.
We have illustrated below some of the VAT issues and opportunities that you may face.
Background – it’s complicated
Charities apply VAT regulations like any other organisation, although they have a number of specific VAT reliefs that may apply, to income and expenditure. The application of reliefs is mandatory, except where a qualifying certificate must first be issued by a charity.
Despite expenditure related reliefs, VAT is incurred on most purchases and it is often a significant cost for charities. This is because charity income streams and activities often fall within exemption from VAT, or are not by way of ‘business’. VAT relating to exempt or non-business activities is irrecoverable from HMRC. A charity can only claim its VAT if it relates to a ‘taxable’ business activity, and where the charity is registered for VAT. Taxable business activities are where, in summary, a charity supplies goods or services, expecting in return a payment or other form of consideration, and where the VAT treatment of the supply is standard (20%), reduced (5%) or zero (0%) rated.
What income will be exempt?
The most common examples where exemption applies to charities will be services of education, healthcare, care & welfare, training or domestic property rental.
What are non-business activities?
These are services provided by a charity where no charge is made and no reciprocal arrangement exists, i.e. one where both parties expects a benefit of substance from the other.
A non-business activity may be funded from a charity’s own reserves, or paid for from Outside the Scope of VAT income (O/S), typically grants, donations and legacies. Whilst grants and donations may be indicative of there being a non-business activity, they can also support a business activity where charges made are below cost. Hence this is not always straightforward to determine.
Is the distinction between ‘business’ and ‘non-business’, or exempt and zero-rated income important?
It is. A charity must understand its activities not only for its day to day compliance but also and especially if it intends to incur a significant amount of money in refurbishing or building a new property or annex.
In essence, understanding the treatment of income and activities is necessary because it:
- Determines the need to be VAT registered and to pay the right VAT to HMRC;
- Directly drives the ability to reclaim VAT incurred; and
- Impacts on reliefs a charity can benefit from in respect of properties, such as:
- Construction of a ‘Charitable’ annex;
- Construction of a new ‘Relevant Charitable Purpose’ (RCP) building;
- Leasing or renting properties without VAT usually applied by landlords; and
- Paying 5% VAT on fuel and power supplies.
What are the VAT issues with charity properties?
1. Misunderstanding of ‘charitable’ use
The above-mentioned property reliefs rely on the intended ‘charitable’ use of the asset, which for VAT purposes is different from the direct tax meaning of ‘trading’ and ‘non-trading’. ‘Charitable’ use means ‘non-business’ use, and not usually as an office if that manages other business activities of the charity.
Getting this wrong can lead to a significant exposure, e.g. a charity believing its newly built property is zero rated (VAT free) but subsequently finding that some or all of the VAT initially saved is clawed back by HMRC.
A certificate must be given by a charity to the contractor (cannot be given to subcontractors) which certifies the intended use of the property. HMRC can penalise the charity rather than contractor for incorrect certification, to the value of VAT that would be due on construction.
2. 5% allowance for ‘business’ use
Although zero-rating for new charitable buildings and annexes relies on the property, or part, being used ‘solely’ for non-business purposes, there is in fact a 5% business use allowance. How this is calculated may require creativity, an understanding of useable criteria, what HMRC may accept is ‘fair’ and what the charity intends to do over the next 10 years.
There are opportunities to achieve zero-rating especially because of this 5% business use allowance but you will need help to ensure a relief can be achieved. You will need to understand how the relief can be achieved and also the risks associated with use of the property after construction, which needs managing over a 10 year period to avoid an exposure.
Changing the use of some or all of a new charitable building within 10 years after construction, including exceeding the 5% ‘business’ use allowance, will lead to a clawback of some of the VAT saved, i.e. that would have been due on construction, had the zero-rating not applied. This is a tapered provision, considering the number of years remaining in the 10-year life of the asset. A change of ownership, even if to an associated body, may also trigger a change in use charge.
4. 5% VAT on fuel and power purchases
This again relies on the non-business use by a charity, or other ‘qualifying’ use, typically residential use. The relief also relies on a certificate being issued to the supplier, which if wrong can lead to penalties for the charity, equal to the VAT undercharged.
Charities often get this wrong. They may think that use is ‘charitable’, when it is not, such as a head office which manages all the activities of the charity. Or they may not have a method of calculating mixed use, such as a private school (which charges fees, but may also have boarding facilities). Further Education colleges can also be at risk because whilst they do not charge for the education of most of their students (up to 19 years), they do have business, fee paying, students; some properties may predominantly be used for adult education for example.
5. Relevant Residential Properties (RRP) use
A charity may have care homes or provide support in other seemingly domestic properties or institutions, such as a hostel for the homeless with complex needs.
There are a number of issues that can arise, which carry the same exposures as for new build charitable use properties:
- Is the property newly built or an enlargement of an existing home, or is it a staged development where only the first phase can be zero-rated?
- What was the property before conversion, and what will it be after? Residential conversions often are relieved at 5% VAT, but that relies on a change in the property.
- Is the property let similar to a ‘hotel, inn or boarding house’, in which case rents are likely to be at 20% VAT?
6. VAT incurred on landlord rents and leases – can this be mitigated?
If a charity hires, leases or rents a property or room/s from a landlord, there may be an opportunity to ‘disapply’ the landlord’s Option to Tax so that no VAT is incurred by the charity. That may be good for a charity but may also cause an issue for a landlord – as the landlord’s supply reverts to being exempt from VAT.
Another issue that can be significant is where a charity takes a lease in a commercial property that the landlord is refurbishing. A contribution to the landlord’s works can in certain circumstances disapply the landlord’s Option to Tax, giving rise to exempt supplies by the landlord and a VAT cost on its works.
7. Charitable housing associations
The rent from social housing is VAT exempt and so VAT on expenditure incurred by a housing association in developing schemes will be an irrecoverable cost. There are, however, acceptable ways to mitigate VAT that may be incurred.
One is a special ability to disapply a seller’s Option to Tax. Another turns the sale of standard rated land into the zero-rated sale of partly completed new dwellings. And there are Design & Build structures, which allow professional fees – not relieved from VAT at all – to effectively take on the same rate of VAT as the development works. Hence this is effective for zero-rated or reduced-rated (5%) projects, and where the properties will be used for exempt or non-business purposes.
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