In this update on VAT Risks for Charities, Lyn Canning Hagan, Director and Eddie Broomfield, VAT Manager of GMcG’s Charity Team comment on some of the VAT risks for charities and not for profit organisations of which Charity Trustees should be aware. These VAT risks potentially apply whether or not your organisation is already registered for VAT.
In particular, whether a ‘grant’ is consideration for a supply of goods or services and potentially subject to VAT. Some clarification has been provided in this area by an update in January 2018 to HMRC’s VAT Internal Guidance on grants.
For VAT purposes, a charity’s income falls into one of the following two categories:
Non-business – where the charity is not required to provide any goods or services in return for the funding or the charity is not making a supply in the course of furtherance of business
Examples include: donations and grants (where monies are freely given with no expectation of anything in return other than accounting for use of the money)
Business – a charity will normally receive business income if it makes a supply of goods or services in return for income
Examples include: charity shop sales, supplies of education, welfare services, cultural admission charges, sports activities, sponsorship and income from the letting of property
Consideration of the business status of charity income is important as it is the first step in determining whether a charity may have an obligation to register for VAT and account for VAT on certain income.
If a charity receives non business income, this income isn’t required to be taken into account when considering whether the charity has an obligation to register for VAT.
If a charity receives business income, the next step is to determine the VAT liability of such income, either taxable or exempt.
If a charity’s business income does not fall within, or satisfy the conditions of, a VAT exemption (see below), such income shall taxable for VAT purposes at the standard-rate (20%), reduced-rate (5%), or zero-rate (0%).
A requirement to register for VAT arises if either:
a) At the end of any month the value of the charity’s taxable income in the twelve months then ending exceeded the VAT registration threshold (£85k from 1 April 2017); or
b) At any time there are reasonable grounds for believing the value of the charity’s taxable income in the next thirty days alone will exceed the VAT registration threshold.
If either of the above tests is breached, the charity must register for VAT and account for VAT at the relevant rate on taxable business income. It should be noted that HMRC has the power to backdate VAT registration up to 20 years which could give rise to a substantial historic VAT liability particularly if the charity is not entitled to charge this VAT to its funder/customer.
It is therefore critical that a charity understands whether any of its sources of income are taxable for VAT purposes.
If a VAT exemption applies to a source of business income such income isn’t required to be taken into account when considering whether a charity has an obligation to register for VAT.
VAT exemptions are potentially applicable to business income received by charities in a number of categories including:
Cultural admission charges
Fund raising events
However, it should be noted that various conditions are attached to these VAT exemptions and a charity may need to take steps to bring itself within the conditions of the relevant VAT exemption for it to apply to a source of income.
1. Grants vs Contracts for Services
A ‘grant’ received by a charity may be non business income or may in fact be a contract for services and accordingly business income for VAT purposes. This will depend on the terms but more importantly, the factual position. The VAT business status of each funding received by a charity must be considered individually.
If the funding is business income and taxable, say at the standard-rate of 20%, the charity may be required to register for VAT (under rules discussed above) by reason of that one funding alone. This could lead to a significant VAT liability for the charity if it is unable to pass on the VAT charge to the funder and must pay such VAT to HMRC out of its own reserves or finance the VAT payment. Additionally, HMRC may seek to levy penalties and interest in respect of the VAT liability.
VAT registration also has a wider impact upon charity business income as VAT may also be due on other sources of taxable business income which a charity receives.
In what circumstances is a ‘grant’ a contract for services and business income?
A key principle when a charity receives funding is whether that funding is consideration for a supply of goods or services to the funder.
If the funding is made by the funder with no additional conditions attached, other than say to report as to how to funds are spent, then the funding will normally be non business income for VAT purposes.
If a grant is non business income, then it isn’t required to be taken into account when considering whether a charity has an obligation to register for VAT.
Difficulties can arise where a charity is required to go beyond reporting on how funds are spent; if it is the case that there is a clear and direct link between the monies being paid and services provided in return; or where the funder is actually procuring services from a charity by, for example, effectively outsourcing an activity to a charity, then this could be a contract for services and business income.
In our experience, there is an ever increasing trend for funders to use ‘contracts’ to provide funding to charities and a risk that the charity is in fact providing a service to the funder, or at least cause for HMRC to argue that such ‘contracts’ are business income.
2. VAT exemptions applicable to charity income
As highlighted above, specific VAT exemptions can apply to various sources of income received by a charity.
However, the risk for a charity is that it did not historically, or does not currently, satisfy all the conditions of the relevant VAT exemption.
Some of the VAT exemptions require a charity to ‘ring fence’ certain profits and apply them only for future use in the category to which the VAT exemption applies. Historically, this ring fencing of profits may not have been undertaken by a charity, especially if a charity was not aware of the requirement, meaning such income could be taxable for VAT purposes.
Additionally, charities may not be in a position or may not wish to utilise a VAT exemption if it means profits from a particular category of income must be ring fenced and can not be used to contribute to the charity’s general overheads.
What Charity Trustees should take away from this is that the application of VAT rules to charities is complex. There isn’t a general VAT exemption applicable to charities and VAT exemptions which are available to certain categories of income have very specific conditions to be satisfied.
This leaves considerable potential risk of an unexpected VAT liability if a charity’s grant income does not fall to be non business or if VAT exemption does not apply to its business income.
Charity Trustees can take steps to mitigate the VAT risk by identifying early whether funding is, or could be, subject to VAT. This leaves time to seek professional VAT advice and to liaise with funders where appropriate.
Lyn and Eddie are highly experienced in providing specialist VAT advice to the charitable and not for profit sector and would welcome the opportunity to discuss if any of the above could be applicable to your organisation.
Please do not hesitate to contact Lyn or Eddie for a free initial no obligation consultation on 028 9031 1113 or by email below:
Disclaimer: The views expressed in this article represent an outline of the relevant provisions and are not intended to be exhaustive. No action should be taken on the basis of information contained herein in respect of any specific case without obtaining the necessary professional advice. No responsibility for loss occasioned to any person acting or refraining from action as a result of the material in this article can be accepted by GMcG Chartered Accountants.