Technical briefing

VAT on public grants and contracts

Finance | 31 May 2012

Chris Lane explains the VAT implications of contracts between charities and public bodies.

When a public body outsources a service to a charity there are essentially two different funding methods available to the public body to finance the service: by grant-funding the charity or by procuring services from the charity under a contract. The VAT position, and the differences from a charity’s point of view between grant-funding and procurement, are as follows.

A grant by a public body to a charity is not a business transaction for VAT purposes. That being so, the charity is not making any taxable supply to the public body and there is nothing on which VAT could be payable by the public body. The public body, therefore, does not have to budget for paying VAT on the amount of the grant. However, because the charity is not making any taxable supply to the public body, the charity is not entitled to recover any VAT for which it is liable on its attributable costs. The charity will have to bear the cost of the irrecoverable VAT and should take that into account in its budgeting.

Procurement by a public body of a service from a charity under contract is a business transaction for VAT purposes. Where the service is subject to VAT the public body will pay VAT on the purchase price of the service. It will normally then be able to recover the VAT under its statutory right of recovery. Equally, the charity will be able to recover the VAT for which it is liable on its costs attributable to the service. Where the service is an exempt supply, however, the public body will not pay VAT on the purchase cost of the service, but neither will the charity be able to recover any of the VAT for which it is liable on its attributable costs.

From a charity’s point of view, where all other things are equal:

• If the charity’s service is a taxable supply, a procurement arrangement is more VAT-efficient than a grant arrangement;
• If the charity’s service is an exempt supply there is no effective difference between grant and contract – the VAT costs of the charity are equally irrecoverable, and there is no VAT for the public body to recover.

The choice of funding method will always depend on a range of factors. Tax-efficiency should not be the determining or the main factor, but it should be one of the factors to be weighed in the balance. It would be irrational not to take into account the tax consequences of different funding methods since it might mean that charities were failing to make the most efficient use of their resources.

Chris Lane is policy officer at Charity Tax Group  

Directory: Charity Tax Group