Tax Factor
07 May 2010
To Register or Not to Register? – VAT is the Question!
Whether they should register for VAT is an issue which concerns many charities. In this article we consider some of the advantages and disadvantages of doing so and take a look at some of the often quite complex issues that need to be taken into account when making this decision.
In this context, a charity must consider firstly ‘Do we need to register for VAT?' and, if not ‘Is there an opportunity to register?'
The obvious advantage to be gained from registering is the ability to reclaim VAT incurred on expenditure. So the next issue to consider is ‘How much input VAT do we stand to reclaim?'
The most obvious downside to VAT registration is the administrative burden, which can be, and usually is, fairly severe. Charities are often faced with the whole gamut of VAT liabilities and complexities - non-business, business, standard, reduced- and zero-rated as well as exemption from VAT. They are arguably, therefore, more complex from a VAT perspective than big banks and insurance companies but invariably do not have the resources to cope.
A good starting point for addressing the first issue of whether there is a requirement for a charity to register is to be clear about the type of activities being carried out. Unlike most other VAT registered entities, charities must consider whether or not the activities being undertaken are by way of ‘business' or not.
Business and Non-business Activities
The activities of most charities can be divided into two clear categories:
- Business
- Non-business
Business activities can normally involve providing some goods or performing some service in return for a consideration (usually monetary). One key point is that the activity does not need to be profit driven for it to be considered ‘business'. Indeed it is quite common for a charity to conduct a business activity that produces an overall loss which is then funded by other income, typically grants or donations or from general reserves from fundraising activities.
The following common activities of a charity would be considered as ‘business':
- Holding functions or events for which an admission charge is made ;
- Providing benefits to members, sponsors or ‘donors' in return for a payment - possibly a regular payment such as a subscription;
- Services provided by an official of the charity in return for a payment; and,
- Letting or sub-letting of space.
Turnover from taxable business activities needs to be in excess of the current VAT registration threshold of £70,000 per annum for a charity to be required to register for VAT.
A ‘non business' activity is arguably more difficult to label but is generally something carried out that is not based on standard commercial principles - in other words, it may not be carried out in return for consideration by a third party and/or it may not be a regular occurrence.
Grants and donations are the most common sources of ‘non-business' income a charity would expect to receive.
The distinction between ‘business' and ‘non-business' activities is probably best explained by way of an illustration (see text box).
Dealing with VAT on Expenditure
One of the difficulties faced by charities is that non-business activities afford no right to recovery of VAT incurred on expenditure.
Claiming input VAT is the main incentive for charities registering for VAT on a voluntary basis - which they are eligible to do if they conduct some activities which generate taxable business income even if this is at a level below the registration limit quoted above.
As a first step, a charity should identify possible sources of expenditure that are either zero- or reduced-rated or exempt from VAT (or subject to reduced-rate VAT) because, even when VAT registered, most charities will not be in a position to reclaim all of their input tax. This is because some VAT will probably be relevant to either non-business activities or exempt supplies (or a combination of both).
A charity is eligible for specific reliefs from VAT, either reduced- or zero-rating or exemption. For example, zero-rate relief is available for the onward sale of any donated goods e.g. second-hand clothes. Perhaps less common, but usually involving much more money, is the relief available for certain works carried out on property, provided the building is used for a ‘relevant charitable purpose'.
A common example of an exemption is that available for the proceeds of certain ‘one-off'* fundraising events (*in actual fact, ‘infrequent' would be a more accurate term).
There are also situations when a charity could benefit from the reduced rate of VAT (5 per cent), the main examples being fuel and power costs and on energy-saving materials.
A charity will also of course be able to enjoy zero-rating and exemption on goods and services that are zero-rated for all businesses, e.g. certain printing and postage costs.
Overall, it is important that charities and their advisers are pro-active in ensuring that the charity does not pay unnecessary VAT in the first instance. However incurring some (perhaps significant amounts of) VAT at the full current rate of 17.5% is unavoidable.
Voluntary Registration
Which brings us back to seeking a registration on a voluntary basis although, as previously stated, exempt and non-business activities afford no right to recovery of the VAT incurred on expenditure. VAT on costs incurred which relate directly to these activities, such as the letting of space in the example outlined above, will be wholly irrecoverable. VAT on ‘overhead' expenditure will be recoverable in part - meaning that the twin spectres of ‘business/non-business apportionment' and ‘partial exemption' rear their ugly heads.
Further, HMRC are likely to insist that a VAT registered charity which receives half its funding from grants and donations will only to be able to reclaim - as a starting point - 50% of its overhead VAT. The obvious advantages of registering for VAT, mentioned earlier, perhaps begin to diminish.
However, help is at hand! The HMRC view is not the only one on offer. There are a number of ways in which potential VAT costs to charities can be mitigated and whilst some of these have been alluded to above, charities should seek specialist advice on the particular measures which could be effective for them.
