VAT – Input tax claims. Latest from the courts

By Marcus Ward 1 June 2020

Latest from the courts

In the recent First Tier Tribunal (FTT) case of Aitmatov Academy an otherwise unremarkable case illustrates the care required when making input tax claims.

The quantum of the claim was low and the technical issues not particularly complex, however, it underlined some basic rules for making a VAT claim.

Background

A doctor organised a cultural event at the House of Lords for which no charge was made to attendees. The event organiser as shown on the event form was the doctor. Aitmatov Academy was shown as an organisation associated with the event. It was agreed that the attendees were not potential customers of Aitmatov Academy and that the overall purpose of the event was cultural and not advertising.

Issues

HMRC disallowed the claim. The issues were:

HMRC contended that the expenses were not incurred by the taxpayer but by the doctor personally (the doctor was not VAT registered)
that if the VAT was incurred by the Academy, it was not directly attributed to a taxable supply
that if the VAT was directly attributed to a taxable supply, it was business entertaining, on which input tax is blocked

Decision

The FTT found that the Academy incurred the cost and consequently must have concluded that the Academy was the recipient of the supply, not the doctor.

However, the judge decided that the awards ceremony was not directly or indirectly linked to taxable supplies made or intended to be made by the Academy, and therefore that the referable input tax should not be allowed. Consequently, the court did not need to consider whether the event qualified as business entertainment.

On a separate point, the appellant contended that, as a similar claim had been paid by HMRC previously, she could not see the difference that caused input VAT in this case to be disallowed. The Tribunal explained that its role is to apply the law in this specific instance and as such it cannot look at what happened in an early case which is not the subject of an appeal.

Commentary

A helpful reminder of some of the tests that need to be passed in order for an input tax claim to be valid. I have written about some common issues with claims and provided a checklist. Broadly, in addition to the tests in this case, a business needs to consider:

whether there was actually a supply
is the documentation correct?
time limits
the VAT liability of the supply
the place of supply
partial exemption
non-business activity – particularly charity and NFP bodies
if the claim is specifically blocked (eg; cars, and certain schemes)

I have also looked at which input tax is specifically barred.

Finally, “entertainment” is a topic all of its own. I have considered what is claimable here in article which includes a useful flowchart.

As always, the message is; if a business is to avoid penalties and interest, if there is any doubt over the validity of a claim, seek advice!

VAT: Intention is crucial – The Sonaecom case

By Marcus Ward 18 May 2020

We cannot control the future…

The Sonaecom case

In the opinion* of the CJEU AG (C-42/19) the importance of a taxpayer’s intention was of utmost importance, regardless of whether that intention was achieved.

Background

Sonaecom intended to acquire a telecoms provider company. As is usual in such cases, input tax was incurred on consultancy received, from, amongst others; accountants and legal service providers. The intention post acquisition was for Sonaecom to make certain charges to the acquired co. These would have been taxable supplies.

Unfortunately, the intended purchase was aborted.

The issue

The issue before the AG was; as no taxable supplies took place as the deal fell through – to what should the input tax incurred on advice be attributed?

Opinion

In the AG’s view the fact that the acquisition was aborted was no reason for the claim for input tax to denied. This was based on the fact that:

Sonaecom was not a “pure holding company”
There was a genuine intention to make taxable supplies (to the acquired co)
There was a direct and immediate link between the costs and the intended supplies
Although the acquisition costs would exceed the proposed management charges, this was not a reason to invalidate the claim
The above analysis was not affected by the fact that the transaction did not take place

Commentary

There are often issues in relation to intentions of a taxpayer. It is clear, and was emphasised in this case, that intention is all important. Of course, intentions can change over a period of time and commercial and political events may thwart or cause intentions to be re-evaluated. There is often an issue about evidencing an intention. HMRC usually require comprehensive documentary evidence to demonstrate an objective. Such evidence is sometime not available for various reasons. Consequently, it is prudent for businesses to record (board meeting minutes etc at the very least) the commercial reasons for taking a certain course of action. This issue quite often arises in transactions in land and property – which can create additional technical issues.

There is legislation in place to cover situations when intentions, or actual events change and which affect the original input tax position: The Capital Goods Scheme (CGS) and The Value Added Tax Regulations 1995, Regs 108 and 109.

Other areas of VAT which often to raise issues are management charges and holding companies. HMRC apparently continue to be eager to attack taxpayers in these areas and I have looked at the role of holding companies and the VAT treatment here, here and here.

I think it is useful to bear in mind a question which, in itself does not evidence an intention, but provides commercial coherence – Why were the costs incurred if there was no intention to make the acquisition? This does leave aside the future management charges position but goes some way to provide business logic.

It will be interesting to see how this case proceeds, but I would find it very surprising if the court diverges from this AG opinion.

* AG’s Opinion

The Court of Justice of the European Union (CJEU) consists of one judge from each Member State, assisted by eleven Advocates General whose role is to consider the written and oral submissions to the court in every case that raises a new point of law, and deliver an impartial opinion to the court on the legal solution.

VAT: Recovery of input tax on fuel costs

By Marcus Ward 22 April 2020

Fuel costs

Road Fuel Scale Charge (RFSC) simplification.

It is common for a staff member to use a car for both business and private purposes (a staff member also covers sole proprietors and partners). Input tax is only recoverable in respect of the business use, so an apportionment is required. This may be done in the following ways.

Apply the RFSC. This is a set figure per month which represents a disallowance for private use and is repaid to HMRC
Keep detailed mileage records and only claim for the business element
If a business pays a mileage allowance for exact business miles travelled it may reclaim input tax on that actual payment. HMRC publish approved Advisory Fuel Rates, which are used to calculate the payments and the recoverable VAT
Do not make a claim at all (if business mileage is minimal or the administration outweighs the cost benefit)

Application

One RFSC must be applied for each car that is used both privately and for business. The fuel scale charges are calculated according to a car’s CO2 emissions and the fixed charge is added to the output figure on the VAT return.

A business will need to check the relevant car’s CO2 emissions figure. This is available for the car’s log book. For dual fuel cars, the lower of the two figures is used.

The calculation

The RFSC allows a business to account for the VAT on fuel in monthly, quarterly or annual returns. When calculating VAT on fuel, if the relevant car has a CO2 emission of 160g, and the business files quarterly returns, the VAT inclusive consideration for a three-month period is £319.00.

The RFSC for the private use of the vehicle will then be calculated as follows: £319.00 x 1/6 (the VAT fraction of the total figure) = £53.16

In this example, the VAT output tax due to HMRC is £53.16 and this is included in Box 1 of the VAT return.

This amount will compensate for any private use of fuel where VAT has already been claimed on the initial purchase of the fuel.

Notes

If a business uses the Flat Rate Scheme no VAT is reclaimable on fuel and no scale charge is applicable.

The RFSC does not apply to commercial vehicles (vans, lorries etc) however, if there is a significant level of private mileage, VAT claims should be adjusted to exclude input tax on this.

HMRC publish updated RFSC valuation tables annually. The latest table is here

Input tax claims may be restricted due to partial exemption or non-business activities.

Help

HMRC have also published a useful ready reckoner tool which assists with the process here

Mileage payments

If a business recovers input VAT based on mileage payments made to employees, it must ensure that employees submit fuel VAT receipts evidencing that they have incurred costs and VAT on fuel. Without such receipts, HMRC may deny the VAT recovery on mileage reimbursements. Clearly, the total VAT incurred on fuel must exceed the business element claimed.

Penalties

Unfortunately, as always with VAT, if errors are made, penalties and interest could apply.

Coronavirus Update – Import VAT and Duty deferral

By Marcus Ward 14 April 2020

HMRC has announced new measures aimed at easing the tax burden on businesses which import goods.

The Chartered Institute of Taxation (COIT) has received the following information:

Businesses can defer payments due next on 15 April in certain circumstances

Urgent action is required.

Duty deferment account holders

Duty deferment account holders who are experiencing severe financial difficulty as a result of coronavirus and who are unable to make payment of deferred customs duties and import VAT due on 15 April 2020 can contact HMRC for approval to enter into an extended period to make full or partial payment, without having their guarantee called upon or their deferment account suspended.

The account holder should contact the Duty Deferment Office using the details below.

Tel: 03000 594243

Email: cdoenquiries@hmrc.gov.uk

Conditions

To use the measure a business will need to demonstrate how coronavirus has impacted its business’s finances and cash flow.

If a business has a Duty Deferment account, it will be able to use its account during the extended payment period agreed, unless it defaults on a subsequent payment in that period. if this happens, HMRC may suspend the account.

The outstanding payment will not affect a business’ duty deferment limit so there will be no need to increase its guarantee to cover the outstanding payment. Interest will not be charged on the outstanding payments provided they are paid in full by the agreed date.

Duty and import VAT payments – non duty deferment account

If a business is a registered importer who pays VAT and Duty at the time of import and is facing severe financial difficulties as a direct result of coronavirus, it can contact HMRC to request an extension to the payment deadline. Again, HMRC will ask for an explanation of how coronavirus has impacted the business’ finances. HMRC will then decide whether to agree an additional time to pay (TTP).

If the request is approved the conditions, including the length of time offered, will depend upon the individual circumstances and may require the holding of a guarantee for the period of the time extension. This facility is not available to non-registered importers.

For further information, please contact the Customs Debt Policy inbox custdebtrr.customspolicy@hmrc.gov.uk

A general guide to the latest on imports here.

Budget 2020 – VAT implications

By Marcus Ward 11 March 2020

A summary of how the 2020 budget changes VAT rules:

e-publications

Zero rating will apply to e-publications from 1 December 2020. This brings e-publications in line with traditional printed matter. The zero rate will apply to:

e-books
e-newspapers
e-magazines
academic e-journals

Presumably, this brings an end to HMRC’s arguments set out in the News Corp case.

Postponed Accounting

From 1 January 2021 postponed accounting will apply to all imports of goods, including those from the EU. This will provide an important boost to those VAT registered UK businesses which are integrated in international supply chains as they adapt to the UK’s position post Brexit.

Sanitary products

From 1 January 2021 the zero rate will apply to women’s sanitary products. This is calculated to save the average women £40 over her life.

Consultation

A consultation paper will be published to gather views on the potential approach to duty and tax-free goods policy post Brexit.

Cross-border goods policy

An informal consultation process will be launched in spring 2020 on the VAT and Excise treatment of goods crossing UK borders after Brexit.

Fund management

As announced on 4 March 2020 the government is legislating to clarify when fund management services are exempt from VAT.

Financial services

An industry working group will be set up to review how financial services are treated for VAT purposes. Presumably how Brexit will affect such services.

“Quick Fixes” Directive

Legislation will be introduced to simplify rules for the VAT treatment of intra-EU movements of call-off stock, allowing businesses to delay accounting for VAT until the goods are called-off.

Partial Exemption

Following the recent call for evidence on the simplification of the VAT rules on Partial Exemption and the Capital Goods Scheme, the government has said it will continue to engage with businesses in relation to their responses and will publish a response in due course.

Commentary

These proposed measures will be broadly be welcomed by business. Especially those in relation to e-publications and Postponed Accounting. It was widely expected that HMRC would lose its argument that e-publications and hard copy publications should be treated differently in any case. Postponed Accounting takes us back to the pre-1990s era. It looks very much like this means a “No-Deal” and although Postponed Accounting may be an easement for some aspects, it remains unnecessary if an agreement with the EU can be reached. However, there appears to be no political will nor appetite to reach such an agreement, so business suffers.

VAT: Interaction of Clawback and the Capital Goods Scheme – The Stichting Schoonzicht case

By Marcus Ward 10 March 2020

Latest from the courts

The difference between intended use and first actual use of an asset.

In the Dutch case of Stichting Schoonzicht (C‑791/18) the AG was asked to provide an opinion on the interaction between clawback and the Capital Goods Scheme (CGS) via Directive 2006/112/EC, Articles 185 and 187. Details of the CGS here. In the UK clawback is set out in The General Regulations 1995, Reg 108.

Background

Stichting Schoonzicht constructed a number of apartments which it intended to sell on completion. This would have been a taxable supply and afforded full input tax recovery on the costs incurred on the development. Unfortunately, due to market conditions, the business was unable to find buyers at the appropriate sale price. Therefore, a decision was made to let some of the flats on a short-term basis until the market picked up. This was done and created an exempt supply. The intention to make taxable supplies remained, but in the meantime, exempt supplies had actually been made. This could affect the original input tax claim. Details of partial exemption here.

Technical

The Dutch referring court entertained doubts about the compatibility of the ‘first-use full adjustment’ requirement provided for under Netherlands law and the CGS.

So the issue was whether the CGS (Article 187 of the VAT Directive) applied such that any required adjustments to the initial input tax claim could be made via a CGS calculation, or whether, as the Dutch authorities contended, there should be a one-off clawback of the input tax previously claimed.

Decision

In the AG’s opinion, the Dutch tax authorities could clawback 4/7 of the input tax on the construction (as four of the flats were let and three remained unoccupied). The AG decided that the CGS could co-exist with clawback and that EU Member States are allowed to adjust the initial deduction of input tax using clawback where actual use varies from intended use. A distinction was made between clawback and the CGS. The CGS is intended to adjust input tax claims as a result of fluctuations in the taxable use of capital assets over a period of time (ten years for buildings in the UK).

Commentary

In the UK, there are published easements for input tax recovery in similar circumstances: “VAT: Partial Exemption – adjustments when house builders let their dwellings”. However, this is an interesting AG opinion, is worth a read and it will be interesting to see how this develops. However, with prior planning, this situation may be avoided in the UK (where new house sales are zero rated).

Should I form a VAT Group? Pros and Cons

By Marcus Ward 4 March 2020

VAT Grouping

This is a very concise summary of matters that should be considered when deciding to form or disband a VAT. Grouping is optional although HMRC have powers to refuse an application in any case where it is necessary for the protection of the revenue.

What is a VAT group?

VAT grouping is a facilitation measure by which two or more entities can be treated as a single taxable person (a single VAT registration) for VAT purposes. The measure was once restricted to “Bodies Corporate” which includes; companies of all types and limited liability partnerships. However, from 1 November 2019, grouping is additionally available for all entities, including; partnerships, sole traders and Trusts in certain cases.

It is important to recognise the difference between a corporate group and a VAT group – these are two different things and it should not be assumed that a corporate group is automatically a VAT group.

It is worth remembering that it is possible to VAT group where no taxable supplies are made outside the group.

Pros

only one VAT return per quarter – less administration
the representative member accounts for any tax due on supplies made by the group to third parties outside the group. This is particularly helpful if accounting is centralised
no VAT on supplies between VAT group members. No need to invoice etc or recognise supplies on VAT returns
usually improves the partial exemption position if exempt supplies are made between group companies
may improve input tax recovery if taxable supplies are made to a partly exempt group company
if assets are hived up or down into a group company before a company sale to a non-grouped third party, the VAT consequences of the intra-group movement may be ignored
may provide useful planning opportunities/convenience at a later date
sales invoices issued, or purchase invoices received, in the wrong company name would not require time-consuming amendment
there may be cashflow benefits in respect of intra-group charges
reduced chance of penalties on intra-group charges

Cons

all members of the group are jointly and severally liable for any VAT due
former VAT group members are also liable for any VAT debts due during the period of VAT group membership
only one partial exemption de-minimis limit for group – which decreases the ability to fully recover input tax
obtaining all relevant data to complete one return may take time thus possibly missing filing deadlines
a new VAT number is issued (previous ones are cancelled – which may lead to administration etc issues)
the representative member needs all of the necessary information to submit a VAT return for the group by the due date
via anti-avoidance provisions, assessments can be raised on the representative member relating to earlier periods when it was not the representative member and even when it was not a member of the group at that time
the limit for voluntary disclosures of errors on past returns applies to the group as a whole (rather than each company having its own limit)
the payments on account (POA) limits apply to the group as a whole. This applies to a business whose VAT liability is more than £2 million pa. This adversely affects a business’s cashflow
the cash accounting limit of £1,350,000 applies to the group as a whole (rather than each company having its own limit)
Transfers of Going Concerns (TOGCs) acquired by a partly exempt VAT group may result in an irrecoverable VAT charge as a result of a deemed self-supply
an option to tax made by a VAT group member is binding on all present and future members of the VAT group. This is so even after a company has left the VAT group

We strongly recommend that professional advice is taken when a business is either considering forming a VAT group, or when thought is being given to disbanding one. Making the wrong decision could be very expensive indeed. Specific matters that dictate VAT advice are when:

property is involved
intercompany charges are made
TOGCs are involved
costs in respect of restructuring are incurred (a current hot potato in the courts)
there is an international aspect to a group
a reverse charge applies
a company has been involved in the penalty regime
companies become insolvent
a VAT group is subject to POA
a company, or the VAT group, makes exempt supplies.

We are always happy to advise when required.

VAT: EC AG’s Opinion – Are aphrodisiacs food?

By Marcus Ward 2 March 2020

Latest from the courts

It’s rare to come across anything vaguely sexy about VAT, but hey ho, aphrodisiacs were the subject of the AG’s opinion in the case of “X” – the name of the Dutch business. The document was published by the European Commission (EC) and is here but unavailable in the English language, presumably as a result of Brexit, unless anyone knows of any other reason.

Opinion

The AG, M. Maciej Szpunar decided that no, aphrodisiacs cannot be treated as food via Directive 2006/112/CE – Article 98 and are therefore not subject to a reduced rate (which would have been zero rated in the UK). The relevant element was:

“Foodstuffs” intended for human consumption “refers to products containing nutrients, and which are in principle consumed for the purpose of supplying said nutrients to the human body”. Products which are normally used to supplement or replace foodstuffs “Means products which are not foodstuffs, but which contain nutrients and are consumed in place of foodstuffs to supply these nutrients to the body, as well as products ingested in order to stimulate the nutritional functions of food or products used to replace them.

Therefore, in the AG’s opinion, the powders and capsules sold by X are different to foodstuffs and supplements and were not subject to the reduced rate. The fact that they may contain elements of nutrition did not override that they were intended to stimulate sexual desire and it was not the intention of the legislation that such products should be subject to the reduced rate as they were not “essential goods”.

That, of course, does not mean that foods which are said to contain aphrodisiac properties such as; asparagus, oysters, watermelons, celery and pomegranates are not reduced rated.

I doubt that Aphrodite – the Greek goddess of love and beauty, knew that ultimately there would be a court case on the rate of indirect tax applicable to such, err; “stimulants”.

AG’s Opinion

The Court of Justice of the European Union (CJEU) consists of one judge from each member state, assisted by eleven Advocates General whose role is to consider the written and oral submissions to the court in every case that raises a new point of law, and deliver an impartial opinion to the court on the legal solution.

VAT: Top 10 Tips for small businesses and start-ups

By Marcus Ward 17 December 2019

At some point it is likely that a small business or start-up will need to consider VAT. Here are a few pointers:

Should you be registered for VAT?

If your income is above £85,000 pa of taxable supplies, you have no choice. But you can voluntarily register if below this threshold. There are significant penalties for failure to register at the correct time.

Advantages of VAT registration: VAT recovery on expenses plus, perhaps; gravitas for a business
Disadvantages: administration costs plus a potential additional cost to customers if they are unable to recover VAT charged to them (eg; they are private individuals) which could affect your competitiveness

More here

Even non-registered businesses can save VAT

Look to use non-VAT registered suppliers, or non-EU suppliers (however, this may count towards your registration turnover)
If you are purchasing or leasing commercial property, consider looking for non-opted property or raise the issue of your inability to recover VAT in negotiations on the rent
Take advantage of all zero and reduced rates of VAT reliefs available
Challenge suppliers if you consider that a higher rate of VAT has been charged than necessary

Consider using the appropriate simplification scheme

Flat Rate Scheme (1% discount in first year of registration)
Cash Accounting (helps avoid VAT issues on bad debts)
Annual Accounting (can generate real, cash flow and/or administrative savings)
Margin schemes for second-hand goods

Further details here and here

Make sure you recover all pre-registration and/or pre-incorporation VAT

VAT incurred on goods on hand (purchased four years ago or less) and services up to six months before VAT registration is normally recoverable.

Are your VAT liabilities correct?

Many businesses have complex VAT liabilities (eg; financial services, charities, food outlets, insurance brokers, cross border suppliers of goods or services, health, welfare and education service providers, and any business involved in land and property). A review of the VAT treatment may avoid assessments and penalties and may also identify VAT overcharges made which could give rise to reclaims. Additionally, these types of business are often restricted on what input tax they can reclaim. Check business/non-business apportionment and partial exemption restrictions.

Charities and VAT

By Marcus Ward 6 November 2019

Surely charities don’t have to pay taxes?

This is a common myth, and while charities and NFPs do enjoy some VAT reliefs, they are also liable for a number of VAT charges.

Charities have a very hard time of it in terms of VAT, since not only do they have to contend with complex legislation and accounting (which other businesses, no matter how large or complicated do not) but VAT represents a real and significant cost.

By their very nature, charities carry out “non-business” activities which means that VAT is not recoverable on the expenses of carrying out these activities. Additionally, many charities are involved in exempt supplies, eg; fundraising events, property letting, and certain welfare and educational services, which also means a restriction on the ability to recover VAT on attributable costs.

These two elements are distinct and require separate calculations which are often very convoluted. The result of this is that charities bear an unfair burden of VAT, especially so since the sector carries out important work in respect of; health and welfare, poverty, education and housing etc. Although there are some specific reliefs available to charities, these are very limited and do not, by any means, compensate for the overall VAT cost charities bear.

Another issue is legal uncertainty over what constitutes “business income” for charities, especially the VAT status of grants. It is worth bearing in mind here the helpful comment in the EC case of Tolsma translated as: “…the question is whether services carried on by [a person] were carried on for the payment or simply with the payment”.

Many charities depend on donations which, due to the economic climate have fallen in value at a time when there is a greater demand on charities from struggling individuals and organisations.

What can be done?

Ensure any applicable reliefs are taken advantage of.
If significant expenditure is planned, ensure that professional advice is sought to mitigate any tax loss.
Review the VAT position to ensure that the most appropriate partial exemption methods and non-business apportionment is in place.
Review any land and property transactions. These are high value and some reliefs are available. Additionally it is possible to carry out planning to improve the VAT position of a property owning charity.
Review VAT procedures to ensure that VAT is declared correctly. Penalties for even innocent errors have increased recently and are incredibly swingeing.
Consider a VAT “healthcheck” which often identifies problems and planning opportunities.

We have considerable expertise in the not for profit sector and would be pleased to discuss any areas of concern, or advise on ways of reducing the impact of VAT on a charity.

More detail on VAT and Charities for guidance

Business activities

It is important not to confuse the term ‘trading’ as frequently used by a charity to describe its non-charitable commercial fund-raising activities (usually carried out by a trading subsidiary) with ‘business’ as used for VAT purposes. Although trading activities will invariably be business activities, ‘business’ for VAT purposes can have a much wider application and include some or all of the charity’s primary or charitable activities.

Registration and basic principles

Any business (including a charity and NFP entity or its trading subsidiary) that makes taxable supplies in excess of the VAT registration threshold must register for VAT. Taxable supplies are business transactions that are liable to VAT at the standard rate, reduced rate or zero rate.

If a charity’s income from taxable supplies is below the VAT registration threshold it can voluntarily register for VAT but a charity that makes no taxable supplies (either because it has no business activities or because its supplies or income are exempt from VAT) cannot register.

Charging VAT

Where a VAT-registered charity makes supplies of goods and services in the course of its business activities, the VAT liability of those supplies is, in general, determined in the normal way as for any other business. Even if VAT-registered, a charity should not charge VAT on any non-business supplies or income.

Reclaiming VAT

This is usually a two stage process (a combined calculation is possible but it must have written approval from HMRC – Notice 706 para 7) . The first stage in determining the amount of VAT which a VAT-registered charity can reclaim is to eliminate all the VAT incurred that relates to its non-business activities. It cannot reclaim any VAT it is charged on purchases that directly relate to non-business activities. It will also not be able to reclaim a proportion of the VAT on its general expenses (eg; telephone, IT and electricity) that relate to those non-business activities.

Once this has been done, the remaining VAT relating to the charity’s business activities is input tax.

The second stage: It can reclaim all the input tax it has been charged on purchases which directly relate to standard-rated, reduced-rated or zero-rated goods or services it supplies.

It cannot reclaim any of the input tax it has been charged on purchases that relate directly to exempt supplies.

It also cannot claim a proportion of input tax on general expenses (after adjustment for non-business activities) that relates to exempt activities unless this amount, together with the input tax relating directly to exempt supplies, is below the minimis limit.

Business and non-business activities

An organisation such as a charity that is run on a non-profit-making basis may still be regarded as carrying on a business activity for VAT purposes. This is unaffected by the fact that the activity is performed for the benefit of the community. It is therefore important for a charity to determine whether any particular transactions are ‘business’ or ‘non-business’ activities. This applies both when considering registration (if there is no business activity a charity cannot be registered and therefore cannot recover any input tax) and after registration. If registered, a charity must account for VAT on taxable supplies it makes by way of business. Income from any non-business activities is not subject to VAT and affects the amount of VAT reclaimable as input tax.

‘Business’ has a wide meaning for VAT purposes based upon Directive 2006/112/EC (which uses the term ‘economic activity’ rather than ‘business’), UK VAT legislation and decisions by the Courts and VAT Tribunals. An activity may still be business if the amount charged does no more than cover the cost to the charity of making the supply or where the charge made is less than cost. If the charity makes no charge at all the activity is unlikely to be considered business.

An area of particular difficulty for charities when considering whether their activities are in the course of business is receipt of grant funding.

Partial Exemption

The VAT a business incurs on running costs is called input tax. For most businesses this is reclaimed on VAT returns from HMRC if it relates to standard rated or zero rated sales that that business makes. However, a business which makes exempt sales may not be in a position to recover all of the input tax which it incurred. A business in this position is called partly exempt. Generally, any input tax which directly relates to exempt supplies is irrecoverable. In addition, an element of that business’ general overheads are deemed to be in part attributable to exempt supplies and a calculation must be performed to establish the element which falls to be irrecoverable.

Input tax which falls within the overheads category must be apportioned according to a so called; partial exemption method. The “Standard Method” requires a comparison between the value of taxable and exempt supplies made by the business. The calculation is; the percentage of taxable supplies of all supplies multiplied by the input tax to be apportioned which gives the element of VAT input tax which may be recovered. Other partial exemption methods (so called Special Methods) are available by specific agreement with HMRC.

My flowchart may be of use: partial exemption flowchart

De Minimis

There is however relief available for a business in the form of de minimis limits. Broadly, if the total of the irrecoverable directly attributable (to exempt suppliers) and the element of overhead input tax which has been established using a partial exemption method falls to be de minimis, all of that input tax may be recovered in the normal way. The de minimis limit is currently £7,500 per annum of input tax and one half of all input tax for the year. As a result, after using the partial exemption method, should the input tax fall below £7,500 and 50% of all input tax for a year it is recoverable in full. This calculation is required every quarter (for businesses which render returns on a quarterly basis) with a review at the year end, called an annual adjustment carried out at the end of a business’ partial exemption year. The quarterly de minimis is consequently £1,875 of exempt input tax.

Should the de minimis limits be breached, all input tax relating to exempt supplies is irrecoverable.

Summary

One may see that this is a complex area for charities and not for profit entities to deal with. Certainly a review is almost always beneficial, as are discussions regarding partial exemption methods.

Please click here for more information on our services for charities.