Guest post by Les Howard of vatadvice.org
It is often said that the first rule of VAT is to assume nothing! In the charity sector, this is especially true. One assumption that is incorrect is that charities don’t have to think about VAT. The reality is that charities often have a greater exposure to VAT than corporate organisations of a similar size and complexity.
For most businesses, VAT ‘washes through.’ They charge their clients VAT which they pay to HMRC. And they claim VAT incurred on their costs.
In contrast, many charities have to navigate a whole set of complex VAT questions. And, having achieved satisfactory answers, they can still only claim a proportion of the VAT they incur.
So, VAT is actually more relevant to charities than to businesses.
This blog introduces important concepts which apply to every charity. This will not give you the answer to every VAT issue, but it does provide some of the key questions that you should be asking.
The definition of ‘business’ activity
The legislative definition of business “includes any trade, profession or vacation.” Decades of case law has ensured that this definition applies very widely. Consequently, a charity engaged in a thoroughly ‘charitable’ activity may find that its activities are deemed to be ‘business’ in relation to VAT. In a worst-case scenario, a charity may find it has to be registered from a date some years earlier. Since its main cost will almost certainly be staff salaries, there will be little input tax to offset against the arrears of output tax. The impact can be substantial.
The concept of ‘supply’
Having determined that a charity is involved in ‘business’ activities, the next question is to identify the ‘supplies’ made and whether those supplies are taxable or exempt.
VAT is charged on a ‘supply’, whether of goods or services. We might equate ‘supply’ with ‘transaction.’ VAT is therefore quite different from other taxes; PAYE is a tax on your salary. Corporation Tax is a tax on profits. But VAT applies to an individual transaction. So, an organisation which receives and makes 1,000 transactions in a year has potentially 1,000 VAT decisions to make in that year!
Since there are some VAT reliefs available to charities, it is also worth determining those supplies received by the charity. For example, some sub-contracted services might be eligible for VAT exemption. Some property related costs can also be zero rated or exempt. (Watch for further blogs on these issues.)
Taxable or exempt?
A supply is either exempt from VAT, or taxable, which means it is subject to VAT, whether at 0% or 5% or 20%. In some cases, a transaction may involve a pack – for example, the provision of supported living accommodation.
When considering whether a charity is required to be registered for VAT or indeed whether it is eligible to be registered for VAT, the value of any exempt supplies is excluded. So, a charity which makes only exempt supplies cannot register for VAT. Any VAT it incurs is therefore a cost.
In contrast, if a charity makes taxable supplies, it can then claim (some) VAT it incurs.
Is funding donation or consideration?
One of the very difficult areas is whether money received by a charity is a grant or donation, which would mean there is no supply, or ‘consideration’ for a supply, which is either taxable or exempt. The way funders operate is in constant flux, which means the VAT outcome might change over time.
There are a set of criteria to be considered whether money is a grant or consideration for a supply. HMRC guidance is provided in this link: www.gov.uk/hmrc-internal-manuals/vat-supply-and-consideration/vatsc06300
Whether the charity prefers the income to be treated as grant funding or consideration for a taxable supply will depend on its own specific circumstances.
Another question is that of sponsorship. It may be that an individual ‘sponsors’ the care of a chosen animal in a rescue centre; or a business sponsor’s medical research bearing its name. Whether that payment represents consideration for a supply depends on a number of factors. If the value of benefits received is minimal, then the amount paid can be treated as a donation. If the value of benefits is more than minimal, then the amount paid is consideration for a supply and the VAT liability has to be determined as commented on above.
It may also be that if you are advising the charity, that you can recommend changes to ensure the preferred VAT outcome.
When considering the preferred outcome, I look at whether the charity has substantial input tax stake and also whether the organisation providing the funding can recover VAT.
Third party consideration
One issue commonly faced by charities, but not often faced by business organisations is that of third party funding. One obvious characteristic in the sector is that the persons receiving supplies are not the same persons paying for those supplies. Recipients frequently cannot afford such services. Therefore funding is provided by third parties. VAT legislation is drafted such that this does not usually affect the VAT outcome.
For example, a local authority funds 100 school children to attend an activity holiday. The supply is made by the holiday provider and may be taxable or exempt. In fact, since local authorities enjoy their own VAT refund scheme, it can be advantageous that such supplies are taxable. They can recover the VAT even though it is the school children that enjoy the holiday.
Many charities provide services which fall into, or might fall into, one of the VAT exemptions. This poses a whole set of complex questions. The first point to note is that the exemptions depend on nature of services supplied AND wording of constitution or other governing document, or financial policy. A second blog explains these exemptions.
For some good news there are a number of specific VAT reliefs applicable to charities. These can provide some cost savings, so do read HMRC guidance.
Advertising is zero-rating when supplied to a charity. This includes advertising in a newspaper or magazine, radio or television, and online advertising.
Social media advertising may be zero-rated, but this depends on the complex area of targeting of recipients. This is something of a hot topic at the moment. So, if you spend substantial sums with Facebook either directly or via an agency, it is worth seeking advice on this point.
Supplies of gas and electricity provided to a charity for its charitable activities are charged at 5%, the same rate as domestic supplies. If the charity uses the premises supplied for both charitable and business activities, then the position is more complicated, with VAT applying at 5% and 20% depending on the proportions of charitable and business use of the premises. There is some detailed guidance on this issue here >
There are other VAT reliefs in relation to property development which will be covered in a later blog. Sign up to the Beyond Profit newsletter to ensure you do not miss it.
You can find out more about Les Howard and connect with him here via LinkedIn