Charities & VAT

VAT continues to give rise to a significant need to be aware of the complexities of the law and persistent challenges from HMRC. VAT has not escaped HMRC’s more proactive approach in seeking to challenge tax treatments particularly where it can potentially give rise to significant windfalls irrespective of the sector and impact.

One particular area of focus continues to be that of charities, which do not have a general exemption from VAT. There are, however, reliefs available which are specific to charities and not-for-profit organisations. Timely recognition of planning opportunities in relation to VAT and forward planning to ensure accurate application of VAT rules can protect a charity’s exposure to the risk of failure to deal with VAT accurately. This article will look at two of the most difficult areas for charities in relation to VAT namely the VAT status of income and property transactions by charities.

Charity income VAT status

Firstly, a charity must decide if its income is ‘business’ or ‘non-business’ income for VAT purposes. Business income is potentially subject to VAT and non-business income is outside the scope of VAT. The definition of business for VAT purposes is governed by specific rules and regulations based on EU VAT Directives, UK VAT legislation and case law. Accordingly, even though an activity may be carried out by a charity in the furtherance of its charitable aims and objectives, the income from a particular activity may still be deemed a business activity for the purposes of VAT.

If it is determined that an income source is business income for VAT purposes, the VAT status of the income must then be considered. The VAT status can be either ‘taxable’ or ‘exempt’ for VAT purposes.

Income which is taxable will be subject to VAT at one of the following rates: standard rate (20%), reduced rate (5%) or zero rate (0%). Income which is exempt is not subject to VAT.

If it is determined that an income source is non-business income for VAT purposes, the VAT status does not have to be determined as the income is treated as outside the scope of VAT. A notoriously difficult area in which to determine the VAT status of income is in relation to the distinction between grants (non-business and thus outside the scope of VAT) and contracts for services (business and thus either taxable or exempt supplies for VAT purposes).

Charities & commercial property transactions

Not only is it important to determine correctly the nature of the income for VAT purposes and the corresponding correct VAT treatment, the VAT status of the income will determine the level of recoverability of input VAT on expenditure by the charity. Recovery of input VAT is determined on the basis of the attribution of the input VAT to the relevant income source. The nature of a charity’s activities from a VAT perspective also determines the VAT implications of any property transactions a charity enters into for use by the charity for its activities and in particular, the entitlement to relief from VAT on such transactions, where applicable.

VAT cannot be charged on a property transaction unless it is properly chargeable and the contract provides for VAT in addition to the amount payable under the contract. A property transaction by a charity can currently be subject to VAT at the standard-rate (20%), zero-rate (0%), exempt from VAT, outside the scope of VAT or a mixture. It is therefore vitally important to consider the VAT implications of a property transaction at the outset.

There are many VAT considerations to be taken into account when a charity is entering into a property transaction. For example:

• Does the transaction involve the acquisition of a ‘new’ freehold commercial building and is thus subject to standard-rated VAT?
• Is the property long leasehold and thus the acquisition is exempt? This applies unless the vendor has elected to charge VAT which is often referred to as making an ‘option to tax’. An option to tax must be notified by the vendor to HMRC.
• Is the vendor’s ‘option to tax’ in fact dis-applied? In these cases no VAT can be charged on the acquisition or letting of the property because the charity has notified the vendor or landlord that the charity will use the property ‘solely’ (95% test) for non-business charitable purposes.
• Is the construction of a new building zero-rated because it is a qualifying supply to a charity for use ‘solely’ (95% test) for non-business charitable purposes?
• Is the transaction outside the scope of VAT? In this case, no VAT is charged because this is a supply of property with the benefit of occupational leases. This means that the property already has tenants who are remaining when the charity acquires the property and thus the purchase of the property qualifies as a ‘Transfer of a Going Concern’ of a property letting business to the charity.

Early identification of the VAT position in any property transaction is extremely important and each of the various examples above in relation to charities are subject to very complex and specific conditions being satisfied.

Transfer of a going concern – property letting case

A very interesting case was decided at the Upper Tax Tribunal during the past year. That was the case of HMRC v Royal College of Paediatrics and Child Health et al [2015] UKUT 0038. The case gives an important insight into an extremely complex area of VAT and property law.

In summary, a college sought to acquire a property that, in the main, it would occupy itself. The seller had opted to tax the property and accordingly VAT would have been due on the sale of the property; which would have been to some significant extent an irrecoverable cost to the college. The transaction was progressed on the basis of a transfer of a property letting business by virtue of agreements for lease being signed by the seller with other parties to rent parts of the building. Consequently, the sale of the property was purported to be subject to the Transfer of a Going Concern (TOGC) rules for VAT purposes. As a TOGC, the sale of the property would be outside the scope of VAT.

The sale of a property letting business can be a TOGC and generally it is sufficient that only an agreement for letting is signed. It is not a requirement that the whole of the property is let. However, in this case the College had introduced the tenants to the seller and given all the facts of the case, the Upper Tax Tribunal were not satisfied that the seller was carrying on a property letting business for the purposes of the TOGC rules.

The case is important however as it does highlight the potential for a TOGC in circumstances where there is a genuine property letting business and a buyer is not able to recover a VAT charge, for example, where charities, not-for-profit organisations and exempt or primarily exempt businesses are involved. Extreme care is required as there are a number of other conditions to be satisfied within anti-avoidance VAT legislation and it should also be ensured that there are no onerous Capital Goods Scheme adjustments post acquisition of the property. A seller’s Capital Goods Scheme flows through to the buyer on a TOGC transfer.

Adult colouring books

Adult colouring books are becoming increasingly promoted as a method of increasing mindfulness and relieving stress. It has been reported that the sales of adult colouring books have exploded in the past year with sales in the UK in excess of £20m.

These are generally currently treated as zero rated supplies for VAT and given the level of sales this has caught the attention of HMRC who are considering if the standard rate of VAT should apply and should always have applied. HMRC are suggesting that these books are actually characterised as stationery and should be subject to standard rate of VAT like diaries, address books and stamp albums being items sold with a view to being completed.

It is understood that there is no indication that HMRC shall seek to change the VAT status of children’s colouring books from being zero rated. A decision from HMRC is expected at some time during this year. If deemed to be standard rated will HMRC seek VAT on past sales?

Conclusion

Close attention to VAT and its application for charities is vital as VAT legislation, HMRC’s interpretations and case law evolves. Specialist advice should be taken.

Lyn Canning Hagan is Head of Taxation at GMcG Chartered Accountants

Email: haganl@gmcgca.com