VAT implications for charity funding
Charities which have traditionally been given local authority grants are now increasingly being faced with having to act as if they have been procured under a contract to deliver a set service, complete with KPIs (key performance indicators) and outcomes. This can have significant VAT implications and give rise to accounting considerations which charities need to be aware of.
With greater scrutiny and accountability around the use of public bodies’ funding and budgets, contractual arrangements of this nature have become more and more commonplace in recent years. The knock-on effect is that agreements which charities have to enter into are becoming more complex.
From the start it is important to distinguish the difference between what is considered a grant and what is a contract.
Grants to support charities
A grant is a voluntary payment to support a charity to further its objectives, and can only be used for the purposes for which it has been given. If the grant is for the overall objectives of the charity, as opposed to use to support a particular project, the funding is usually deemed as unrestricted income.
In instances whereby the grant is supporting a set service, any surplus funding on completion of the project can be retained by the recipient organisation, unless a clause is included in the contract contrary to this.
Performance related grants will involve terms requiring performance of a specified service, and payment is conditional on specified outputs and if objectives have been delivered. Due to the payment being voluntary this is still recognised as a grant.
Contracts being binding agreements
A contract, on the other hand, is a binding agreement which distinguishes the supply of goods or services for a set fee and over a set period of time. Charitable organisations can enter into contracts if the terms further the charity’s objectives. Unless otherwise stated in the contract, any retained surplus on the performance is retained by the charity and the income is classed as unrestricted.
VAT dimension
The benefits of avoiding errors at the outset of entering into a contract or accepting a grant cannot be underestimated.
If mistakes are made, it can be extremely costly in terms of time and also funds at a later date when HMRC carry out an inspection – especially if the charity no longer has the funds there to make up for a shortfall! Penalties and additional interest charges can also be added by HMRC.
So what do charities need to bear in mind when considering VAT and accounting issues?
In the cases of grants and contracts, charities sometimes have difficulties determining if the agreement is classed as a business transaction and if therefore VAT is due to be paid.
Although VAT is charged on most business transactions in the UK, a donation or a grant to a charity is not classed as business transaction and is not subject to VAT in a number of instances.
For instance, if a charity does not give the donor any benefit of value in direct exchange for a donation, or if the charity does not give a third party any benefit of value, and likewise if the donation has not been made subject to any other conditions.
In the main, VAT is a tax which falls on the end user of a product or service, and cannot be recovered by the final consumer.
Where it can get complicated is that while the organisation responsible for selling the service to the end user is liable for VAT for the costs of delivering the service, it is also able to recover this VAT.
There are some services however which are classed as exempt from VAT, such as education, care of children and the elderly, social welfare or medical services.
In cases like this, the organisation which sells the exempt service to the end user is still liable for VAT on its costs, but because the services sold are exempt from VAT it is not allowed to recover the VAT.
So for any charities providing exempt services they do not charge VAT, but also cannot recover the VAT they are liable for the attributable costs.
Choice of arrangement
It will be a balancing act for many charities about whether to explore using grant funding or if to enter into a procurement contract.
Traditionally it has been HMRC policy to treat payments described as grants as being outside the scope of VAT.
This was in contrast to money paid over as a payment (or consideration) for a supply under a contract. The nature of grant funding has changed and more and more conditions are now set by grant givers.
In many cases these have become nearly as onerous as the conditions found in contracts for service. Consequently although it is HMRC policy to allow "housekeeping provisions" for grants, the distinction between grants and contracts has become very blurred.
This is especially true if the only reason the work is undertaken is because a grant is received and the grant is obtained under a tender process. In such a case there is a very good argument that the grant is not in fact outside the scope of VAT.
There is less of an issue with non-restricted and core funding, and if you receive grant income it is worth considering if it should be subject to VAT.
Multitude of factors
The reality is that a multitude of factors will go into determining which route a charity should take, and tax-efficiency will in many circumstances not be at the top of this list.
Failing to take into account tax from the outset during decision making could however put charities in an extremely dangerous position. So they need to proceed with caution before entering into any agreements or contracts to protect their position.
The consequences for breach of contract can be severe so before signing on the dotted line, charities need to ascertain if entering into an agreement is in their best interests and if in any doubt should seek professional advice.
The use of contracts and grants is an extremely fast moving subject, and indeed new developments and guidance are imminent - so it’s very much a case of watch this space for the third sector.
