Charities and VAT - beware!

24 May 2016

VAT is now over 40 years in existence. What started out as a simple flat rate of tax at 10% has grown over the years into an ever increasingly complex tax with a standard rate now of 20%. I only have to look at my own VAT library to see how the volume of VAT legislation and related material has expanded over the years. The 1972 Finance Act introduced the original VAT legislation from 1st April 1973 and whilst this legislation was some 50 pages long, the most recent legislation now extends to almost 3,000 pages on VAT alone!

VAT Penalties

It has become increasingly important to ensure accurate compliance, with all taxpayers and entities subject to a more regimented format of penalty regime and less scope for HMRC discretion in relation to penalties. Charities 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 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 being the VAT status of income and property transactions by charities.

Charity Income

Firstly a charity must decide if its income is ‘business’ or ‘non-business’ income. Business income is potentially subject to VAT and non-business income is outside the scope of VAT. While the definition of business for VAT purposes is governed by specific rules and regulations 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.

VAT Status

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 will not be subject to VAT.

If 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 outside the scope of VAT) and contracts for services (business and taxable or exempt supplies for VAT purposes). 

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 shall also determine 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.

Commercial Property Transactions

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-rated (20%), zero-rated (0%), exempt from VAT, outside the scope of VAT or a mixture. It is thereby 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:

•   Is the transaction the acquisition of a ‘new freehold’ commercial building and subject to standard-rated VAT?
•   Is the property long leasehold and the acquisition exempt unless the Vendor has elected to charge VAT? This is often referred to as making an ‘option to tax’ which must be notified by the Vendor to HMRC.
•   Is the Vendor’s ‘option to tax’ in fact dis-applied and 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 shall 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 the use ‘solely’ (95% test) for non-business charitable purposes?
•   Is the transaction outside the scope of VAT and thereby no VAT is charged because it is the supply of investment property with the benefit of occupational leases i.e. a property which already has tenants who are remaining when the charity acquires the property and 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 is extremely important and each of the various examples above are subject to complex and specific conditions being satisfied.

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.

Article produced by Lyn Hagan for Investec Charity Matters, Northern Ireland edition Spring 2016

 LYN CANNING HAGAN

Partner, Tax and VAT Solutions