UK VAT and Charities
VAT incurred on expenditure can be a significant additional cost for charities resulting in a reduction in funds ultimately available for core charitable activities. The impact of VAT on a charity's annual budget is to a significant extent dependent upon the degree of input VAT recovery and also on specific reliefs available. Input VAT recovery is itself dependent on the VAT status of the charity's sources of income, being ‘non-business income’ and/or ‘business income’ and the attribution of input VAT incurred thereto.
A primary source of a charity's income is often non-business income for VAT purposes; for example, the charity is not required to provide any goods or services in return for the funding or the charity is not making a supply in the course or furtherance of a business.
Non-business charity income often includes gifts, donations and grants. Where monies are freely given with no expectation of anything in return (other than accounting for the use of the money) the monies are normally not consideration for a supply and such income is non-business. However, if there is a clear and direct link between the monies being paid and services provided in return, this is more likely to be business income. Funding Agreements should be reviewed at the outset in order to ascertain the nature of the arrangements and the VAT status thereof, ensuring the charity is not exposed to a VAT cost and/or interest and penalties.
Typical examples of charity business income include sales in charity shops, the supply of education/training, welfare or cultural services and income from letting property. Once it has been established that a charity receives business income, the VAT liability of such income must be determined as taxable or exempt.
Input VAT Recovery
Input VAT on expenditure is:
- Recoverable where attributable to taxable activities;
- Irrecoverable, subject to partial exemption de minimis limits, where attributable to exempt activities; and
- Irrecoverable where attributable to non-business activities, irrespective of the quantum.
Residual Input VAT
After direct attribution, input VAT on assets and general overhead costs which are not solely used for one type of activity is required to be apportioned. An appropriate Business/Non-Business calculation is established to firstly determine how much of this VAT relates to the non-business activities of the charity and is irrecoverable. Secondly, the remaining business input VAT is apportioned between taxable and exempt activities of the charity and its recovery is determined using a Partial Exemption apportionment calculation.
A standard method is available based on the ratio of the different sources of income. Alternative methods, known as Partial Exemption Special Methods, which can produce a more favourable result (albeit the method must still be fair and reasonable) can be agreed with HM Revenue & Customs.
From 1 January 2011, a combined Business/Non-Business and Partial Exemption Special Method is available. Although it may be administratively simpler to operate, the partial exemption de minimis limits which enable the recovery of exempt related input VAT are not available for this method.
VAT incurred on the acquisition or construction of a building by a charity can be the most significant VAT cost a charity will incur.
In accordance with VAT Act 1994 Schedule 8 Group 5 Item 1(a)(ii) zero-rating applies to the first grant of a major interest by the person constructing a building “intended for use solely for. a relevant charitable purpose”. Item 2(a) of Group 5 zero-rates the construction of a new building intended to be used solely for relevant charitable purposes. In limited circumstances the construction of a self-contained annex which is intended to be used solely for relevant charitable purposes can also be zero-rated.
In this context ‘solely’ now means that the building must be used 95% or more for relevant charitable purposes (non-business purposes) or as a village hall. Use of the building must be calculated on a ‘fair and reasonable’ basis. To obtain zero-rating the charity shall be required to certify to the vendor/developer that it meets the relevant conditions.
It should be noted that if within 10 years of obtaining zero-rating in relation to a building as detailed above, a charity changes its use of the building from ‘solely’ relevant charitable purposes, a VAT charge may arise in the hands of the charity.
Zero-rating not available
Where a charity is unable to secure zero-rating on the purchase or construction of a building or part of a building, the charity must act early to minimise the VAT cost. Detailed attention to the use of the building is required to maximise the attribution of VAT incurred to any taxable supplies by the charity and where appropriate, ‘opting to tax’ the property where part may be leased out. Often a separate special method for determining input VAT recovery is required and can be negotiated with HMRC.
It should be noted that often the acquisition, construction or refurbishment of a charity building will be subject to the VAT Capital Goods Scheme (CGS) within VAT Regulations 1995, Part XV. Monitoring of the use of the building is required for a period of 10 years and annual VAT adjustments made where required.
There have also been a number of changes which affect the accounting for VAT on property for charities in particular, with effect from 1 January 2011:
- CGS has been widened to include non-business activities;
- Clawback/payback rules which adjust initial input VAT recovery for the change in intended use of an asset have been widened to include non-business use;
- Introduction of an option to exclude an asset, partly used for non-business, from the VAT system completely for all purposes including the CGS and the clawback/payback rules;
- Lennartz accounting for property has been withdrawn.
Disapplication of the Vendor's/Landlord's Option to Tax
Charities can also obtain relief from VAT on the acquisition or lease of a building where the vendor or landlord has opted to tax the building for VAT purposes, and the building is intended to be used solely for a relevant charitable purpose, but not as an office. In this case the landlord's ‘option to tax’ the property can be disapplied and may require negotiation where this impacts upon the landlord's input VAT recovery.
Collaboration and Partnership
With ever increasing pressures on budgets, charities are considering the financial benefits of collaborating on certain projects and working together in ‘partnership’.
Considerable care is required to establish the contractual relationship between the collaborating charities and in turn the VAT status of income arising under such a collaborative project. Particular attention must be paid to establishing if there are any supplies for VAT purposes between the collaborating charities. Any implications for VAT in relation to a property which may be shared or sublet must be considered, particularly if there is a potential for a VAT cost.
Cost Sharing Exemption
In addition to collaborating to share expertise, charities may seek to obtain cost efficiencies by sharing certain back-office resources. Often where such resources are recharged from one charity to another there is a supply which is standard-rated for VAT purposes and a VAT cost shall arise where the recipient charity is unable to recover such VAT.
However, Article 132 (1)(f) of the EU Principal VAT Directive, provides an exemption for certain services provided within cost sharing groups whose members carry out exempt or non-business activities. This mandatory exemption has not yet been incorporated into UK law, although arguably is available. HMRC have however recently a published consultation entitled “VAT: Cost Sharing Exemption” which is due to finish on 30 September 2011.
Other effective VAT saving reliefs to be aware of are zero rating of charity advertising, the fundraising exemption and zero rating for disability access work to a building.
Although VAT can be a significant cost to charities, timely and effective advice and planning, taking into account ever increasing caselaw and changes in legislation, can minimise costs and risks, ultimately increasing and protecting funds available for charitable activities.
Lyn Hagan is Tax Partner at Goldblatt McGuigan Professional Services Group, Alfred House,19 Alfred Street, Belfast, BT2 8EQ Email: firstname.lastname@example.org