‘Business’ is an important concept in VAT as it determines if VAT must be charged and if it can be recovered. Commercial organisations are generally clearly in business, but very often a charity will undertake non-business activities.

There have been a number of cases on the meaning of business for VAT but unfortunately the judgments are often contradictory. The normal approach taken by the courts is to look objectively at what a charity does. If it is providing goods or services in return for a consideration (usually a consideration in money, but not necessarily) then it is seen as being in business.

If an activity is wholly funded by income that is outside the scope of VAT such as grants or donations it will be a non business activity. VAT is not charged on the grant income received but neither can VAT be recovered on the costs incurred.

Subsidised activities, where an activity is partly funded by grants and partly by taxable charges or fees, do give entitlement to VAT recovery, but HMRC will sometimes seek to apply an apportionment to the input VAT recovery. Even though an activity is subsidised, it can still be a wholly business activity, leading to full VAT recovery on associated costs.

VAT Treatment of Grants and Contracts
A common concern for charities is whether they must charge VAT on income. Is it a contract or grant for VAT purposes? Business or non business? If the income is a true grant that is outside the scope of VAT then any activity wholly funded by it will be non-business.

The difficultly is that many scenarios are hybrids and fall between the two extremes of wholly business or wholly non business.

It is often the case that certain arrangements are not correctly described. Just because funding is called “grant”, if it is actually a payment for something specifically supplied in return, it is not a grant for VAT purposes. Although the terms of any agreement should be considered in deciding the VAT treatment in such cases, the facts are also critical.

Another incorrect description is “minimum donation”. If it is a donation, it is freely given, voluntarily. If there is a compulsory minimum required, it is a charge or fee!

The receipt of a grant or outside the scope income does not automatically result in a VAT recovery restriction. A subsidised service where charges are made to customers is still a business activity for VAT purposes. Some HMRC officers try and demand a VAT restriction when they come across any outside the scope income, but this is wrong.

Difficulties can also occur with sponsorship income. If a local supporter gives a donation but requires no acknowledgement then the money they give is clearly outside the scope. The problem occurs if the donor insists on recognition. Here it is often arguable whether VAT is chargeable. HMRC will generally not see a grant making organisation that insists on recognition (such as national lottery funding) as receiving a supply but might well take a different view if the funder is a commercial organisation that benefits from the publicity. This can be more critical if the sponsor is in the VAT exempt sector (e.g. banking, insurance), as they would not be entitled to full input tax recovery.

Although there is a standard method for VAT partial exemption calculations, do remember that there is no set method for non business apportionment, but it does have to be fair and reasonable. In theory, a non business apportionment can be based on any variables, but HMRC do like there to be some logic involved and will want to be able to verify the figures. For example, they are unlikely to accept a time-based apportionment (staff time) if the organisation does not use timesheet recording anyway – they might think that the figures have been made up purely to give a good VAT recovery result!

An income-based method of apportionment may be an easy, one-step calculation from easily identifiable figures, but it might not give a fair or favourable result. Bear in mind that an apportionment based on the same ratio as business income bears to total income can be hugely distorted by large, one-off transactions such as legacies. HMRC will often agree that such distortive transactions can be excluded from an income-based non business apportionment, but it is best to get this confirmed in writing by HMRC. The fact is that a windfall such as a legacy will not result in input tax bearing costs, and its inclusion in an income-based method will not be relevant. The input tax incurred by the organisation will not be directly proportional to the legacy income.

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