Understanding VAT and charities
Do charities pay VAT? This is a common question, and the answer is “yes”…but it’s not simple. Mistakes are easily made, so it is useful to have a broad awareness of the rules so you can identify situations or transactions that might need further consideration or professional advice.
There is no automatic, blanket VAT relief for charity purchases. Yes, there are certain specific, targeted VAT reliefs that apply to certain supplies to charities, but nothing that allows all purchases to be VAT-free. There is also the need for specific declarations/certification to be issued by a charity in order to benefit from the VAT reliefs that are available.
VAT registration rules
The same VAT registration rules apply to charities that apply to any business. They must register for VAT if their taxable supplies exceed the VAT registration threshold (currently £83,000).
Some charity income is outside the scope of VAT, such as grants and donations, and monies obtained from the supply of education or welfare services. Other income, such as that from trading activities, would be subject to standard rate, reduced rate or zero rate VAT. So even deciding if you have to register is complex.
In some cases, a charity may wish to register for VAT voluntarily, as it can recover VAT paid on its costs and could expect a net VAT reclaim from HMRC. As long as the taxable supplies made are only to customers able to recover their input VAT in full, then the need to charge VAT will not add to customers’ costs.
Another situation where VAT registration may be beneficial is if the charity makes taxable sales that are subsidised, and will be able to recover more VAT as input tax than the output VAT it needs to charge.
Trading activities are often channelled through a trading subsidy. This can mean that both a charity and its trading subsidiary are required to be registered for VAT. Sometimes a VAT group registration might be a better option.
VAT grouping is not something to be rushed into, but it does allow supplies between a charity and its subsidiaries to be disregarded for VAT purposes. Also, when there are significant taxable supplies made through a subsidiary, grouping can boost the total VAT recovery rate for the group’s overheads.
Is a charity in business?
"Business" is an important concept in VAT as it determines if VAT must be charged and if it can be recovered. The normal approach taken by the courts is to look objectively at what a charity does. If it is providing goods or services in return for a consideration (usually, but not necessarily, money) then it is seen as being in business.
If an activity is wholly funded by income that is outside the scope of VAT such as grants or donations it will be a non business activity. VAT is not charged - but neither can VAT be recovered on the costs incurred.
Subsidised activities, where an activity is partly funded by grants and partly by taxable charges or fees, do give entitlement to VAT recovery, but HMRC will sometimes seek to apportion the input VAT recovery. Sometimes, even though an activity is subsidised, it can still be deemed to be a wholly business activity.
VAT and grants and contracts
As can be seen, many scenarios are hybrids and fall between the two extremes of wholly business or wholly non business.
It is often the case that certain arrangements are not correctly described. Just because funding is called a “grant”, if it is actually a payment for something specifically supplied in return, it is not a grant for VAT purposes. Whatever the intention, the facts are also critical.
Another incorrect description is “minimum donation”. If it is a donation, it is freely given, voluntarily. If there is a compulsory minimum required, it is a charge or fee!
A subsidised service where charges are made to customers is still a business activity for VAT purposes. Some HMRC officers try and demand a VAT restriction when they come across any outside the scope income, but this is wrong and should be challenged.
Difficulties can also occur with sponsorship income if the donor insists on recognition. Here it is often arguable whether VAT is chargeable. HMRC will generally not see a dedicated grant making organisation (such as national lottery funding) as receiving a supply, but might well take a different view if the funder is a commercial organisation which benefits from the publicity.
Charity VAT recovery
Charities can rarely recover all of the VAT they incur, but the calculation of recoverable input tax is not an exact science.
The first hurdle to calculating input tax recovery is to ensure that the accounting system is able to identify the VAT incurred, and to allocate the VAT in accordance with whether it can be fully recovered or whether it needs to be subject to a restriction for non business use and/or partial exemption.
If the posting of the VAT incurred is wrong, then the whole calculation of recoverable VAT will be undermined – it’s a case of GIGO – garbage in, garbage out!
Do remember that there is no set method for non business apportionment, but it does have to be fair and reasonable. However, HMRC do like there to be some logic involved and will want to be able to verify the figures. For example, they are unlikely to accept a time based apportionment (staff time).
While an income based method may be an easy, one-step calculation from easily identifiable figures, it might not give a fair or favourable result. It can be hugely distorted by large, one-off transactions such as legacies. HMRC will often agree that such transactions can be excluded from an income based, non business apportionment, but it is best to get this confirmed in writing by HMRC.
VAT reliefs for income
There are too many to list all possible VAT reliefs here. If you want the whole picture or have specific issues, then the HMRC website is a good place to start. I will highlight some pitfalls though!
Charity fundraising events
There is a VAT exemption for charity fundraising events. This allows all supplies made at an event to be treated as VAT exempt, unless they are zero rated (such as programmes).
The exemption can be applied to up to 15 events of the same type, in the same place each year – but if there is a 16th event, the exemption will not apply to any of them!
This exemption is available to charities whether they are registered for VAT or not but beware, the events must be fundraisers, not social occasions.
Sale of donated goods
Charities can sell goods donated to them at the zero rate. However, charity shops are increasingly also selling new goods and moving onto a retail Gift Aid scheme.
The zero rate does not apply to the retail Gift Aid scheme, as in this case the charity is receiving a monetary donation from the donor, on whose behalf the goods have been sold, rather than actually selling donated goods. The retail Gift Aid scheme produces a very different VAT treatment for what was traditionally a charity shop selling only donated goods.
Premises and VAT
Some charity construction work can be purchased free of VAT – usually a new build or self contained annex. The rules here require that the building be used solely for a charitable non business purpose. This is a much stricter interpretation than merely a charitable purpose. In practice, HMRC may allow up to 5% business use.
Similar to the relief for certain construction services, a charity buying or renting premises intended for use for a charitable non business purpose can confirm this to the vendor/landlord and the option to tax will be disapplied. This means that no VAT will be charged on the supply. This option does not apply to retail premises.
Working together and mergers
As charities take on more diverse activities, with both central and local government contracting out services, there are big risks if VAT aspects are not considered correctly. I have seen a charity which sub-contracted to a commercial provider and so incurred an additional 20% VAT cost making the whole project uneconomic.
The merger of two or more charities can also trigger VAT problems. Is there a transfer of a business as a going concern? Are there any options to tax or capital goods scheme items taken on? Are there assets that may cause a VAT cost due to change of use?
From outside the UK
Don’t forget that if a charity receives supplies or services from suppliers based outside the UK, it has to account for the VAT that would have applied within the UK. 20% VAT must be declared as both output tax and input tax, and it may not be fully recoverable. Also, the value of reverse charge services received from abroad can trigger a requirement to be registered as their value counts towards taxable turnover.
As I said…it’s complicated!
