For years charities have tried to recover VAT incurred on investment and portfolio management services. Finally, HMRC has now agreed that in certain circumstances VAT on such costs can be partially recovered.

In 1996 the Wellcome Trust  put the case before the European Court of Justice (CJEC Case C-155/94) that its considerable holding of financial investments should be seen as a business activity of the charity. Consequently it argued that VAT incurred on attributable costs was recoverable. The court rejected this deeming it to be ‘non-business’ activity for VAT purposes and thus VAT incurred on related costs was wholly irrecoverable. This same argument had previously been rejected  in 1992 by the VAT Tribunal in the case of the National Society for the Prevention of Cruelty to Children (LON/92/602X).

And so the position remained until 2005 when the High Court decision in the Church of England Children’s Society v HMRC [2005] EWHC 1692(ch) STC 1644 fundamentally changed the ability of charities to recover VAT.

The principle arising from this case had earlier been established at the European Court in Kretztechnik AG v Finanzamt Linz C-465/03 (2005) STI 1118. This is that income from activities directly aimed at increasing the working capital of the organisation does not qualify, for VAT purposes, as consideration. This being so, the VAT incurred on costs attributable to achieving this income should properly be partially recoverable as an overhead cost as increasing the capital is for the benefit of the organisation in general.

Applying this principle to a charity, HMRC now accepts that, following the Children’s Society case, VAT incurred on raising unrestricted funds (ie that would be used to support taxable business activity) can be treated as a general overhead and partially recovered in line with the agreed business/non-business apportionment and partial exemption calculations in place.

This new position now enables charities to partially recover VAT incurred on fundraising costs used to generate unrestricted donations and legacies.

The Nuffield Foundation sought to take these new rules one step further and apply this same principle to VAT incurred on raising unrestricted income via financial investments. ‘No!’ said HMRC. The Wellcome Trust and NSPCC cases referred to above confirm that the holding of financial investments by a charity is a non-business activity and thus any VAT incurred on attributable cost is wholly irrecoverable.

But this is precisely the point. As the income generated is not a consideration for a supply by the charity the VAT incurred on investment managers’  fees should properly be attributed to  the charity’s wider activities and is  thus recoverable to the extent that  they include taxable activities.

It took a bit of time but HMRC has finally accepted this point made by the Nuffield Foundation which should enable many charities to further mitigate their irrecoverable VAT cost.