Another year and more uncertainty about how VAT should be applied to organisations in the charitable sector. It seems that the question of what constitutes a business activity and how much input tax a charity is entitled to recover will continue to be challenged by both HMRC and the taxpayer. All that we can hope for is clearer guidance about the tests that should be applied, rather than any black-and-white solutions. A summary of the case law is outlined below, together with other important changes that have been introduced during the last year and things to look out for in the comings months.
Case law summary
The perennial question of what constitutes an economic activity continues to be a problem. Many believed that the Court of Appeal decision in Longridge on the Thames meant that whenever there was a supply in return for consideration, there is a presumption or general rule that there is an economic activity. This concept was cast aside in the subsequent case of Wakefield College where the Court of Appeal decided that a two-stage test is required: first, whether there is consideration for a supply of goods or services; and, second, whether the goods or services are provided for remuneration ie obtaining income on a continuing basis. This second question requires a far more detailed analysis of all the facts and circumstances about the taxpayer.
Two subsequent cases have tested these principals. Glasgow School of Art spent £21m refurbishing its property on which it had exercised its option to tax. It leased part of this building to the students’ union for £5,000 plus VAT and sought to recover the VAT on associated costs. Both the first tier and upper tribunals found that, while there was a supply for consideration – a direct link between rent paid and occupation under lease – that was not an economic activity because the sums involved did not amount to continuing income. Hence, the tribunals agreed with HMRC that there was no entitlement to input tax recovery.
Yeshivas Lubavitch Manchester (YLM) constructed a building that was to be used as a day school and nursery. A large proportion of the fees were subsidised so the charity argued it was using the building for non-business purposes and issued a zero-rate certificate to the contractor on the basis the building would be used for a relevant charitable purpose (RCP). HMRC argued that, as there was a supply of services in return for consideration, there was a business activity and so no entitlement to the zero-rate relief. The first tier tribunal considered both Longridge and Wakefield, as well as the older cases of Yarborough and St Paul’s and concluded that YLM was not undertaking an economic activity, giving hope to charities generally that perhaps all was not lost following Longridge. There is, however, a possibility of a further appeal by HMRC.
With regards to zero-rate certificates, this appears to be an area that HMRC is paying far more attention to. The case of Greenisland Football Club concerned a charity, which had issued a zero-rate certificate on the basis it was constructing a new building which it would use for a RCP. Although the upper tribunal found that the certificate should not have been issued as the building was to be used for business purposes, HMRC could not impose a penalty on the charity for issuing an incorrect certificate because the certificate had been issued after careful and reasonable consideration by the trustees. The charity had contacted its advisers, who had given oral advice that the building would be zero rated. Interestingly, HMRC argued during the hearing that the charity should have sought clearance from HMRC before issuing the certificate – contrary to what is said in its published guidance.
After many years of litigation, the Court of Justice of the European Union (CJEU) finally gave its decision in the University of Cambridge case. The university receives donations that are invested in the Cambridge Endowment Fund, which invests in a range of securities including equities, property, bonds, cash deposits and other investments. The income generated from the fund is distributed across the university to support all of its activities. These activities could be taxable, exempt or non-business. Cambridge successfully argued in the first tier and upper tribunals that the VAT incurred on its investment management fees was an overhead cost and hence the VAT was partly recoverable. HMRC appealed to the Court of Appeal, which referred the matter to the CJEU.
The CJEU confirmed both HMRC’s and the university’s view that the investment activities did not amount to an economic activity. However, it also found that when raising and collecting donations and endowments, the university was not acting as a taxable person. The investment of the funds and the management of those funds must be treated the same way as the collection of the funds – ie as a continuation of the non-economic activity. The CJEU went on to consider whether there could be an objective link between the cost of management and the wider business activities and referred to the cost component approach – ie were the costs incorporated into the price of a particular supply? It found that the costs relating to the management of donations and endowments invested in the fund were not incorporated into the price of a particular output transaction, hence there was no link to the university’s taxable output and therefore no entitlement to VAT recovery.
While we wait for HMRC to set out its policy following this decision, the Supreme Court decision of Frank A Smart & Son Ltd (FSL) appears to have muddied the waters. In FSL, the question was whether the taxpayer could deduct VAT that it had incurred in purchasing tradeable units, giving rise to the right to obtain farming subsidies known as single farm payments (SFPs), which are outside the scope of VAT. FSL used the funds derived from the SFPs to pay off its overdraft and develop further business operations. The Supreme Court held that FSL could deduct VAT on purchase of the units because the taxpayer was accumulating sums to develop its taxable business through capital expenditure on assets which it would use to generate taxable outputs. This seems to question whether all taxpayers incurring investment management fees will face the same fate as Cambridge and it is hoped HMRC will clarify the position in due course.
Another case to note is the Royal Opera House Foundation (ROH) where the tribunal had to consider what proportion of its production costs ROH could recover. The tribunal found that production costs were linked to income from catering, bar and certain recordings and hence these income streams could be included in the calculations. The tribunal found there were no such links to shop sales and commercial room hire. Unfortunately, the reasons for this are unclear. However, the decision has been appealed and so this is one to look out for, as hopefully the upper tribunal will clarify the principles to be applied in such circumstances.
General issues to consider
Making Tax Digital
Since 1 April 2019, VAT-registered businesses with turnover in excess of the VAT registration threshold are no longer able to file VAT returns via HMRC’s website, but instead must use functional compatible software that can connect to HMRC via an application programming interface to submit their returns. Some organisations, such as VAT groups or trusts and charities that are not companies, were deferred until 1 October 2019. To help businesses meet their digital link requirements, HMRC has allowed a one-year, soft landing period from the original mandation date (VAT period starting on or after 1 April 2019 or 1 October 2019 for deferred businesses). Most organisations have been using bridging software to meet these requirements during this period and are working on ensuring that they meet the requirements for digital links once the soft landing period has expired. On 17 October 2019, HMRC announced that businesses could apply for additional time, if needed, to put digital links in place in order to comply with the requirements of MTD. This additional time will be provided for businesses with complex or legacy IT systems that cannot comply with MTD digital links requirements by the end of the initial soft landing period. The criteria for making an application and how to apply are set out in the VAT Notice 700/22, section 220.127.116.11.
Updated guidance on sponsorship
HMRC has recently updated Notice 701/1 to include guidance on mixed sponsorships and donations. For many years, charities have sought to arrange their affairs so commercial sponsors were making a specific payment for the supply of services, such as the right to use the charity’s name and logo, which was subject to VAT, and a voluntary donation, which was outside the scope of VAT.
Paragraph 5.9.6 of Notice 701/1 now includes HMRC’s guidance on such arrangements as follows:
“Charities will often receive both sponsorship and donations at the same time. Provided the donation is entirely separate from your sponsorship agreement, or your sponsorship agreement document makes clear which part is payment for services, and which is a donation, you are not required to account for VAT on that donation. However, it must be clear that any benefits your sponsor receives are not conditional on the making of the donation or gift.
“Where a charity (or other non-profit making body) agrees to let a commercial business use its name in order to raise donations, there is a supply of the benefit to the commercial business of increasing sales. However, there is no need for all the payments to be assumed to be made in return for the benefit. The value of that benefit must be calculated and a fair value stipulated in the contract. The remainder can be treated as a donation from the commercial business to the charity, and is outside the scope of VAT.
“For example, where a retailer allows customers to vote on which charities will receive donations. While this activity might result in increased sales for the retailer, it is not seen as commercial sponsorship because any benefit received by the retailer may be seen as insignificant. Consequently, the payments received are regarded as outside the scope of VAT.
“It is often regarded as good practice for charities to enter into two agreements with corporate sponsors when entering into charity of the year or similar arrangements. The first is between the charity’s subsidiary and the sponsor over the granting of publicity rights. The second is between the main charity and the sponsor to receive the donation. In this case, the donation will be outside the scope regardless of whether a minimum donation is promised.”
This is a welcomed update and supports some of the arrangements used by charities in the past.
From 1 November 2019, VAT group registration is no longer restricted solely to corporate bodies. Now, individuals and partnerships can also be part of a VAT group, provided the relevant control criteria are met. Unfortunately, the provisions have not been extended to include trusts at this stage and it will be interesting to see whether representation is made to include such bodies.
Areas to look out for
Simplification of partial exemption and capital goods scheme
There was a call for evidence to consider the simplification of partial exemption (PE) and capital goods scheme (CGS) and the closing date was 26 September 2019.
The review was broadly in three sections:
- The first section looks at the process of applying partial exemption special methods and the possible ways in which this might be improved to reduce burdens for taxpayers and HMRC;
- The second section explores how the current PE de minimis limit could be changed to aid simplification;
- The third section considers possible policy solutions to issues caused by the CGS.
It will be interesting to see whether anything comes out of the many comments made by a variety of organisations, but all charities should look out for any announcements as this could impact on current VAT accounting procedures.
Grants of interest in land
HMRC is in the process of updating VAT Notice 742 which includes guidance on what constitutes a licence to occupy land and hence is exempt from VAT. We are aware that following the recent Court of Appeal judgment in Fortyseven Park Street Ltd HMRC is adopting a more narrow interpretation of what constitutes an interest in land. For example, the supply of office accommodation with the right to use shared areas, such as reception areas, lifts, restaurants, restrooms and leisure facilities, will no longer be exempt but taxable on the basis it is a supply of facilities.
Indeed, there is evidence of HMRC arguing that hostel accommodation supplied by a charity is not an interest in land but a supply of facilities. This raises wider questions and so is another area that will need to be monitored closely as HMRC develops its policy.
This really is a watch this space item, with no detailed information to go on or whether it will happen. However, at the very least, organisations involved in the movement of goods into and/ or out of the UK or provide digital services will certainly have new rules to grapple with.
As can be seen from the above, while VAT legislation itself may not change, its interpretation following case law can, and it is of vital importance that charities keep themselves up to date where possible. Similarly, HMRC can itself change its policy and, unfortunately, such changes are not always announced. Having procedures in place to ensure you are aware of changes as far as possible is therefore key to both mitigating VAT problems and filing accurate returns.
Socrates Socratous is a VAT partner at Buzzacott
Charity Finance wishes to thank Buzzacott for its support with this article