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VAT Briefing: VAT made simple when working in partnership

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VAT Briefing:VAT made simple whenworking in partnership

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Funded by

The Finance HubCharities Aid Foundation St. Andrew’s House18-20 St. Andrew StreetLondon EC4A [email protected] (020) 7832 3016f (020) 7832 3001

Development Trusts AssociationCharities Aid Foundation National Office33 Corsham StreetLondon N1 [email protected] 0845 458 8336f 0845 458 8337

acevo1 New Oxford StreetLondon WC1A [email protected] 0845 345 8481f 0845 345 8482

NB: Please note this briefing is a working document which will be updated to includedelegate feedback collected at regional seminars.

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AbstractThere is a common misconception thatcharities and other third sectororganisations are exempt from VATbecause they do not have to paycorporation tax on profits from theircharitable activities.

If commercial businesses work together todeliver a contract for a third party, theyare obliged to charge each other VAT onthe services and goods they provide andsell to each other. Third sectororganisations that are not registeredcharities must pay tax as commercialbusinesses do.

Although charities enjoy some specificexemptions from charging and payingVAT, in general they must charge and payVAT just like commercial businesses. So iftwo charities work together they too arecaught by the same VAT rules asbusinesses.

This briefing explains the most importantrules governing VAT on partnerships. Itthen explains how to make sure that yourpartnership operates within those rules.

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Introduction

Third sector organisations often worktogether, supported by grant fundingprovided by local authorities and othergovernment bodies. Sometimes they aresubcontracted to provide services. Thesesubcontracts are often to provide welfareand educational services that are exemptfrom VAT under EU law.

When working together, third sectororganisations often provide each otherwith services and recharge each other forthose services. For VAT purposes theyhave made “supplies” to each other.Unless the supplies fall within the terms ofthe VAT exemptions or exceptionally canbe charged at the zero rate of VAT, theorganisations must charge each other VATon the supplies.

Most businesses and local authorities canrecover from H M Revenue and CustomsVAT incurred on their costs. However,grant income is outside the scope of VAT.Under EU VAT rules, if income is “outsidethe scope”1 of VAT, you cannot recoverany VAT paid on related costs. Likewise,if your income is “exempt” from VATunder EU law you again cannot recoverVAT paid on your costs.

So, when third sector partners have tocharge each other VAT on shared andrecharged costs this VAT often cannot berecovered; it is an additional cost. But if a single third sector organisationrecharges costs internally between twocost centres there is no “supply” and sono VAT charge.

Third sector partnerships can thereforeresult in what many regard as an unfairadditional VAT bill, leaving them with lessmoney to run their projects.

1 See the “Key Points” for a brief glossary of these technical terms.

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Key points

1. Familiarise yourself with the followingterms:• “Supply for consideration”: the

provision of goods or services inreturn for payment of some kind.This attracts VAT.

• “Consideration”: does not meanjust cash; it includes payment ingoods and services and bartertranslations.

• “Outside the scope”: grant-fundedservices do not count as supplies,so do not attract VAT.

• “Exempt”: exceptional types ofsupplies, including some kinds ofhealth, education and welfareservices, to which VAT does notapply.

• “Zero-rated”: further exceptions,such as food, children’s clothing,and books, where the VAT rate isnil.

2. VAT is a complex tax. Make sure youseek professional advice beforeundertaking new contracts or varyingan existing contract.

3. Although charities enjoy some specificexemptions from charging and payingVAT, in general they must charge andpay VAT just like commercialbusinesses. Do not assume that VATwill not apply, simply because you area charity.

4. Within a partnership, never assumethat services charged betweenpartners will not attract VAT. They maycount as a supply for VAT purposes,even if the partnership was set up todeliver a VAT-exempt service.

5. When making a grant proposal,include any VAT payable on your costsin the grant budget. Likewise, whenbidding for contracts for the provisionof VAT exempt health, education orwelfare services, ensure that budgetsinclude the VAT payable on your costs.

6. Consider the secondment of sharedstaff when you are working inpartnership. Depending on the fundingmodel, secondments may sometimesbe ignored for VAT. This is a complexarea, where specialist advice isrequired.

7. If you seek advice from H M Revenueand Customs, make sure you get itconfirmed in writing. This is partly toensure you understand the positioncorrectly, and partly to ensure the taxauthorities do not later deny or backtrack on verbal advice given!

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How the VAT system works

VAT is a complex tax and thereforedetailed advice should always be soughtbefore undertaking new contracts orvarying an existing contract.

VAT is a European tax: it is ultimatelycontrolled by the EU, not the UKgovernment. Third sector organisationsthat are registered for VAT should alwayswork on the basis that VAT must becharged and paid on any activity theyundertake unless it is covered by aspecific VAT exemption or the rate of VATcharged on that activity is zero.

VAT is charged on the “supply” of goodsand services where “consideration” isreceived in return. “Supply” broadlymeans provision or sale. “Consideration”means payment - which can be apayment in money (cash, cheque, creditcard etc) or instead by making a supplyof goods and services back to thesupplier in return.

For example, administrative services areprovided by charity Viking to charitySaxon, and Saxon pays Viking byallowing them to use their minibus. Thisis known as “a barter”. Even though nocash has changed hands VAT must stillbe charged on top by both Viking andSaxon. Both charities need to ascertain

the value of their supplies to each otherand send each other VAT only invoices at17.5% of the value of their supplies.These must be paid in cash, not by abarter!

The VAT system means that each personin the chain between the first supplier andthe final consumer is charged VAT ontaxable supplies made to him (input tax)and charges VAT on taxable suppliesmade by him (output tax). Mostsuppliers pay over to H M Revenue andCustoms the excess of output tax overinput tax, or recover from H M Revenueand Customs the excess of input tax overoutput tax.

The broad effect of this is that suppliersmaking taxable supplies are not affectedby VAT, except in so far as they arerequired to administer it. The burden oftax falls on the final consumer. However,suppliers making VAT exempt suppliescannot recover VAT incurred on theircosts, because they do not charge outputtax on the supplies.

There is some VAT that, due to specialrules, can never be recovered. Examplesinclude VAT charged on businessentertaining and some of the VAT chargedon the cost of cars.

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VAT exemption

VAT tax was created with the assumptionthat it would be wrong to charge VAT onall supplies, so exemptions exist. Theseexemptions include the rental of property,provision of postage by the nationalcarrier, burials and cremations, finance,and perhaps most importantly for thethird sector, certain services in health,welfare and education.

When the UK joined the EU we decidedthat the exemptions did not go farenough. There were a number of othersupplies we thought should not attractVAT and so agreed with the EU a zerorate of VAT for supplies such as food,children’s clothing, books andnewspapers, equipment for the disabledand public transport. Although the rateof VAT is nil, organisations that make zerorate supplies are still allowed to recoverthe VAT they incur on their costs.

The Education VAT exemption

The VAT exemption for education,training, and research is dependent onwhether the provider is an “eligible body”.

• “Eligible bodies” include schools anduniversities. They also include charitiesand other bodies which are precludedfrom distributing and do not distributeprofits.

• A further condition for exemption isthat any and all profits made fromsupplies of education must be used tocontinue or improve future supplies ofeducation.

“Education” has a wide meaning for VATand includes any course, class, or lessonof instruction or study in any subject. Itdoesn’t matter whether the education isnormally provided in schools, colleges, oruniversities. When and where it takesplace is irrelevant for VAT purposes.

“Education” also includes vocationaltraining, retraining, or the provision ofwork experience for both employees andcharity volunteers.

The Welfare Services VAT Exemption

The welfare services VAT exemptionapplies to services provided by charitiesand public bodies that are directlyconnected with:

• The provision of care, treatment, orinstruction designed to promote thephysical or mental welfare of elderly,sick, distressed, or disabled people, or

• The care or protection of children andyoung persons, or

• The provision of spiritual welfare by areligious institution as part of a courseor retreat (which is not primarily aholiday).

To qualify for the exemption, the servicesmust be “directly connected” to theabove. Services that are peripheral tothese areas, such as relatedadministration, will be subject to VAT. Forexample, imagine that a charity contractswith a local NHS trust to designprocedures and protocols to improvecommunication between patients andhospitals. This work is not directlyconnected with the care of the sick, andso is subject to VAT.

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Grant income

Grant income is not a “supply” for VATpurposes and is therefore outside thescope of VAT. Supplies are two-waytraffic – goods and services going oneway, and payment in return going theother. Grants on the other hand are seenas one-way traffic down to the recipient.The payer is not receiving goods orservices in return. They get no directbenefit from the services carried out bythe grant recipient.

If a third sector organisation carries outwork that a local authority or othergovernment body is statutorily obliged todeliver, the payment for the work cannotbe a grant. It is a fee for subcontractedwork. It is therefore within the scope ofVAT.

However, recent court cases haveindicated that if the local authority orgovernment body is funding work that itis not legally obliged to carry out, thenthe funding for the work will usually be agrant.

Other cases have indicated that where acharity is in receipt of grant funding,retains some of that funding to coveradministration costs, and then makesgrants down to other charities to enablethem to carry out work, the administrationof the grants is not a supply for VATpurposes; there is no VAT chargeable.

Because grants are outside the scope ofVAT, the recipients of grant funding arenot allowed to recover the VAT incurredon related costs.

N.B. Local authorities and othergovernment organisations are often keento structure agreements as grants insteadof as contracts for services. This isbecause they do not have to followcomplex and restrictive procurementrules when making grants.

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VAT and charges between third sectororganisationsVAT charges between third sectororganisations can be a real issue whenworking together on grant fundedprojects or on delivering contracts forservices that are VAT exempt. Twoorganisations working in partnership oftenassume that VAT is ignored when theywork together. This misunderstandingarises because the activity is grantfunded; because the partners thinkcharities are generally exempt from VAT,or because a contract for services is VATexempt (for example, it is an “education”or “welfare” service).

However, the third sector organisationsneed to stand back and consider thenature of the services they provide eachother. Sadly, the VAT status of the workcarried out by the partnership is usuallyirrelevant. Their recharges are usuallyseen as separate supplies, which aresubject to VAT. The VAT usually cannot berecovered because their income is eitherexempt from VAT or a grant.

So, for example, if a charity is contractedto provide welfare services to a localauthority, but subcontracts work out toanother charity, that subcontracted workwill probably fall within the VATexemption.

On the other hand, imagine the same twocharities contract directly with the localauthority to deliver the same service.One charity agrees to deal with theadministration side of the work andcharges the second charity for the cost ofthe administration service. Thisadministration service is not covered byany of the VAT exemptions and so issubject to VAT.

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Suggestions for reducing the VAT pain

The following suggestions will help toreduce the burden of irrecoverable VATfor your charity:

• When bidding for grant funding,ensure that your budgets include theVAT payable on your costs, becauseyou will not be able to recover this VATfrom H M Revenue and Customs.

• Likewise, when bidding for contractsfor the provision of VAT exempteducation or welfare services, ensurethat budgets include the VAT payableon your costs because you will not beable to recover this VAT from H MRevenue and Customs. Unlikecharities, local authorities have specialrules which enable them to recoverVAT on their costs.

• Consider the secondment of sharedstaff. If the agreement is for grantfunding, the VAT impact of rechargescan be reduced by seconding staffbetween the two charities. Suchsecondments are ignored for VAT, andso no VAT is due on salary etcrecharges. This does not apply tocentral administration staff and doesnot apply where the charities arefunded through fees instead of grantsor other donations. This is a complexarea, where specialist advice isrequired.

• If advice is sought from H M Revenueand Customs – ensure you get itconfirmed in writing. This is partly toensure you understand the positioncorrectly, and partly to ensure the taxauthorities do not later deny or backtrack on verbal advice given!

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Third sector views on the VAT regime

The opinion of most charities andumbrella organisations is that the VATcharges that arise from charities workingtogether are artificial and only arisebecause of the narrowness of the law.They provide an unwelcome reason whycharities should not work together.

Many charities and umbrellaorganisations have asked HM Revenueand Customs to make a concession forinter-charity recharges where they areworking together jointly on projects.Sadly, thus far HM Revenue and Customshas not been willing to make any suchconcessions.

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Case Study 1: Dickens and Trollope’s training manualThis case study shows how suppliesbetween charities may attract VAT, evenwhere they are related to grant incomethat is outside the scope of VAT. Sadly,this VAT cannot be recovered.

Two charities, Dickens and Trollope, applyfor and receive grant funding from theLearning and Skills Council to set up andrun adult literacy classes in London.

Neither charity could deliver the wholeservice by itself. They decide to make ajoint application for the funding and agreeto carry out the project in partnership.They are each paid grant funding of£500,000.

Dickens is a large, well establishedcharity with substantial in-houseadministrative support. However, it doesnot have enough trainers free andavailable for the project. Trollope is asmaller charity and while it does not havethe internal resource to administer the

project, it has a large bank of trainers itcan call upon to deliver the classes.

Dickens agrees to write a training manualfor the programme, provided Trollopepays £10,000 towards the cost of this.Dickens and Trollope will use the manualto deliver the training.

The grant funding is VAT free, as it isoutside the scope of VAT. However, thecharge to Trollope for its share of writingthe training manual is subject to VAT of£1,750.

Trollope cannot reclaim the VAT chargedfrom H M Revenue and Customs,because its income from the project isoutside the scope of VAT. This creates anirrecoverable VAT charge of £1,750 in thehands of Trollope.

If Dickens and Trollope had been a singlecharity, no VAT would have been charged.

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Case Study 2: Community and Spirit’s contract administrationThis case study shows how suppliesbetween charities may attract VAT, evenwhere they are related to a contract forservices that are exempt from VAT.Sadly, this VAT cannot be recovered.

Two Charities, Community and Spirit,specialise in providing home careservices to the elderly and disabled.

They jointly contract with their localauthority for the provision of care servicesin their area. They each receive£400,000.

Community agrees to deal with all theadministration and financial issuessurrounding the contract and chargesSpirit £15,000 for its share of theseadministration costs.

The contract is for the provision of VATexempt welfare services. However, theadministration services provided byCommunity to Spirit are not covered bythe VAT exemption and so are subject toVAT of £2,625.

Spirit cannot reclaim the VAT chargedfrom H M Revenue and Customs,because the contract is VAT exempt.This creates an irrecoverable VAT chargeof £2,625 in the hands of Spirit.

If Community and Spirit had been asingle charity, no VAT would have beencharged.

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Case Study 3: Canova’s grants programme This case study shows how no VAT ischargeable within a grants programme,where a charity makes further grants toother charities. This is still true whenthe charity retains some of the grantfunding to cover its administrationcosts.

Canova is a charity that receives a grantfrom an arts body, with the intention thatit administers the grant and makes furthergrants to arts charities to fund their work.

The arts body will receive no benefit fromthe grant-funded work, so it is outside thescope of VAT.

Canova makes grants down to the artscharities Reubens, Turner, and Stubbs.Canova retains 10% of the total grantfunding received to cover itsadministration costs.

Grant funding is simply passing throughCanova to other beneficiary charities.There is no supply for VAT purposes, sono VAT is chargeable.

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Further ReadingThere are various HMRC publications which can bedownloaded from their website, www.hmrc.gov.uk

The author suggests the following VAT Public Noticeswhich can be found on the above website using thesearch facility:

701/1 – Charities701/30 – Education and Vocational Training700/1 – Should I Be Registered For VAT?749 – Local Authorities and Similar Bodies700 – The VAT Guide (a general guide to VAT)

To access the above Public Notices follow theinstructions below:• Go to www.hmrc.gov.uk,• Click on the “business and corporations” section,

click “VAT”,• Then click on “VAT information sheets”,• Then click on “public notices (numerical order)”,• You will find all of the Public Notices listed above

and more there.

About the authorBill Lewis is Tax Consultant to Charity Solicitors BatesWells and Braithwaite. He has over 20 yearsexperience in providing taxation advice to clients in acareer which has spanned working for H M Revenueand Customs, Pricewaterhousecoopers, commerce,and the social enterprise sector. He frequently lecturesand writes on taxation issues affecting charities andhas contributed to the writing of guidance on H MRevenue and Customs website and their VAT notices.

Disclaimer

The information in this article is believed to be correctat the time of publication. It is general in nature and isnot intended to be exhaustive nor to provide legaladvice in relation to any particular situation, andshould not be acted or relied upon without takingspecific advice.

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St Andrew’s House18-20 St Andrew’s StreetLondon EC4A 3AYtel 020 7832 [email protected]

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