VAT and Charities – issues that can arise
It is a myth that charities don’t pay VAT and that HMRC treat them with kid gloves. VAT is paid, commonly a significant cost for charities, and in fact the most important tax they face.
VAT is also particularly complex for charities. Some would say unfairly so as resources for controlling finances and VAT are usually limited, in contrast with larger organisations in other sectors which do have the resources and do have far more straightforward rules.
The complexity arrives partly from the varying VAT treatment that can apply to income and expenditure but also because of the sheer diversity of the sector. One treatment does not fit all; each charity will need to look at its own individual position.
The starting point for a charity wishing to manage its VAT effectively is therefore to accept that its VAT position it likely to vary significantly from other charities and to get help to analyse its individual VAT situation. As we know, a lack of financial governance and control can have a disastrous effect on a charity and VAT has to be recognised as one of the potential catalysts that can spark a fire.
We are fortunate to have very experienced professionals within our charity team that you can consult for help. They focus on VAT only, have throughout their careers with HMRC and the profession, and have specialised in charities for many years.
Here are some of the areas where issues, and opportunities, arise.
1. VAT liability of income
As a default, income from business activities – those services (or goods) for which a charge is made or other consideration expected in return – is normally subject to VAT at the standard rate (currently 20%), unless a relief applies.
However, charities don’t always charge for what they do and are instead funded, meaning that some or all of their activities may not be by way of ‘business’. Freely given funding is outside the scope of VAT, such as grants and donations.
Also, due to the nature of the work charities undertake and the intention of the VAT law not to tax social activities, even though services may be regarded as ‘business’ there is plenty of scope for a charity’s income to be exempt from VAT. Healthcare, welfare and education are the main areas but there are others.
Getting the VAT position of income right is crucial because:
- Not paying VAT due or registering late can lead to retrospective exposures, plus penalties – 4 years for errors and up to 20 years for late registration;
- A charity needs to understand if income will include VAT, or if it can be added to its price, and the effect on the end user;
- The VAT liability of an activity/income stream has a direct effect on whether VAT incurred on expenditure can be reclaimed from HMRC. For example, no VAT applies where income is zero-rated, exempt or outside the scope of VAT and yet the latter two do not usually allow for VAT recovery.
2. VAT registration
A lot of charities are not registered for VAT. This is because VAT registration is only required if taxable income is in excess of the VAT registration limit (currently £85,000). Taxable income is that with a rate of VAT (ie zero 0%, reduced 5% or standard 20%). Therefore, if a charity’s income is outside the scope of VAT or exempt there may be no requirement to be VAT registered.
Income is not the only factor in deciding if registration is obligatory. If a charity buys in goods or services from outside the UK it is often overlooked that the value of these purchases count towards the registration threshold and may create a requirement in due course to register for VAT, or indeed exposure for the past.
Example of overseas costs where this might be relevant are:
- Investment management fees for investment portfolios;
- Overseas agents fees for private schools; or
- Legal fees from abroad.
3. Recovery of VAT on expenditure
A VAT registered charity can only reclaim from HMRC VAT on its expenditure to the extent it is incurred in the course of its taxable, ‘business’ activities. Non-business or exempt activities will not enable associated VAT to be recovered.
If a charity has a mixture of non-business, taxable and exempt activities an apportionment of the VAT incurred is necessary. Typically, this will be VAT on overheads and property costs, but will apply to any item of expenditure which cannot be entirely attributed to taxable services or goods.
The standard method of apportionment is one based on turnover but this does not always achieve the best result for charities, particularly if there are significant non-income generating (non-business) activities. Also, VAT incurred – say at one of a charity’s offices – may be adversely affected by the whole organisation’s exempt income when in fact the office concerned may in fact be used predominantly for taxable purposes. An alternative method can be adopted, based on any other calculable criteria, such as on floor space or staff time, although this will require negotiation and agreement with HMRC before it can be used.
It should be noted that the difference in VAT recovery that a method can achieve can be significant. Also, the retrospective use of an alternative methodology is rarely possible beyond the current tax year. For these reasons you should always review the suitability of your recovery method periodically, certainly wherever there is a reasonably significant change in what you do, and in any event every three to four years.
Additionally, there are special rules for capital expenditure, which require an analysis of use of the item over a longer period (for example 10 years for properties after completion of the works). Any fluctuation in the taxable and exempt use each year will result in either a clawback from or payment to HMRC during this time. Any refurbishments, or new build projects should be considered carefully and from the outset of planning in this regard.
4. VAT reliefs
It’s not all bad news. There are some valuable reliefs available for charities, but it’s fair to say these are tightly controlled and whilst the reliefs from VAT on income or on expenditure are usually obligatory if the conditions are met, qualification is not automatic.
- Zero rating for:
- New build of relevant charitable buildings (non-business use)
- Purchases of drugs and charity funded equipment
- Goods donated to a charity
- Aids and adaptations of goods and properties for disabled persons
- Exemption for fundraising activities
- Reduced rate for a charity’s fuel and power where the building is used for non-business purposes
There are different requirements for the various reliefs including certification in most cases so care should be taken to ensure the relief qualifies. Where significant expenditure is incurred, such as the construction of new buildings or the addition of an annex, specialist advice should always be sought as achieving a zero-rate for the works is far from easy and as there are some nasty clawbacks that can arise depending on the use of the property during a ten year period after the works.
5. Grant vs. Contract
It is not always clear, given the nature of the work that charities do, whether an agreement for payment is in respect of:
- the provision of services (ie a contract), which will generally be at 20% or exempt from VAT; or
- a grant, which will be outside the scope of VAT.
The VAT treatment may not be clear despite how an agreement is worded. Just because it is termed ‘An Agreement for Grant Funding’ does not necessarily mean that it is a grant and outside the scope of VAT. Care should be taken with the VAT treatment when entering into or drawing up agreements.
If it is at all possible that VAT will be due, a charity should ensure that legally the agreement/contract allows for any VAT to be charged at a later date, should HMRC challenge the treatment of funding. It should be noted that it may in fact be beneficial for a contract to be subject to VAT as this can improve a charity’s recovery of VAT on expenditure.
A donation must be freely given with no expectation of anything in return other than a token (eg a poppy) or small acknowledgement. Where it is, it is outside the scope of VAT.
However, where it is clear that the payment is in respect of something given, eg entry to an event, then it will not be a donation and VAT will normally be chargeable (subject to any VAT exemptions that might exist).
Care should be taken where there is a mixture of charge and donation, for example:
- a membership patron scheme where benefits are obtained but there is a large donation element
- events which require a fee and then a minimum or suggested donation.
There are risks in the way that donations and benefits are expressed to the public or corporate donor which can lead to all of the payment including the donation being subject to VAT, even if the benefit a charity provides is clearly small in comparison with the payment/donation made.
7. Subsidiary companies
Not everything a charity does is necessarily ‘charitable’ and it is therefore common for subsidiary companies (trading companies) to be set up to separate the commercial activities from the charitable activities. The VAT implications of this need to be considered:
- The eligibility for reliefs or exemptions may not be available to the trading company as it is not a charity.
- If the trading subsidiary is making taxable supplies, does it need to register for VAT and is it better to register this with the charity as a ‘VAT Group’ to mitigate VAT on intra-group charges, and to improve the recovery of overhead VAT?
- Any apportionment method may no longer be appropriate and may need to be revisited.
For more information please contact Rupert Moyle, VAT Partner or Colin Laidlaw, VAT Director .
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