The last two and a half years have been very challenging for everyone, and charities are no different. Constable VAT advises many charities operating in various sectors. Some clients are large national and international charities, others are smaller locally based organisations. In our experience, the COVID-19 pandemic has impacted them all.
This may have been an adverse effect on income generated, service delivery, illness among staff and volunteers, Government restrictions, and a general level of uncertainty. However, charities have demonstrated that they are resilient organisations that have adapted to the different circumstances faced. The pandemic has also reinforced what a positive impact the sector has, and continues to have, on society generally offering support across many levels.
In terms of VAT, HMRC introduced various schemes designed to help businesses which charities benefited from, and which was welcomed.
Change of policy – Business and non-business activities
It has often been a point of disagreement between a charity and HMRC as to whether a specific activity (or the activities) of a charity is a ‘business’ activity for VAT purposes. This is important because a ‘business’ classification may impact on a charity’s VAT registration status, if the business supplies are taxable, or the right to claim charitable reliefs, the construction of a building for a relevant charitable purpose (RCP) for example. If a charity’s business activities are VAT exempt business activities, this will impact on the amount of VAT incurred that it is able to recover.
HMRC’s preferred cases when considering whether a charity is undertaking a business activity has, for many years, been the decisions in Morrison’s Academy Boarding Houses Association (Morrison’s), and Lord Fisher. These decisions are referred to in HMRC guidance and are both over 40 years old. These cases considered six factors which indicated whether a charity was undertaking a business activity. Morrison’s was accepted by the (then) Inland Revenue as a charity when the case was heard and decided in the late 1970’s.
As case law has evolved it seemed that Morrison’s and Lord Fisher had become outdated, nevertheless, these remained HMRC’s preferred source of reference and were quoted regularly and relied upon by HMRC. On 1 June 2022 HMRC issued Revenue & Customs Brief 10/22 which updates this guidance.
The new guidance takes account of two more recent cases (Longridge on Thames and Wakefield College) and HMRC has confirmed that two tests derived from these decisions will now be the key indicators in determining whether an activity is undertaken by way of ‘business’ for VAT purposes. These tests are as follows:
Stage 1: The activity results in a supply of goods or services for consideration
This requires the existence of a legal relationship between the supplier and the recipient. The first step is to consider whether the supply is made for a consideration. An activity that does not involve the making of supplies for consideration cannot be business activity for VAT purposes.
The Court of Appeal in Wakefield emphasised that a ‘supply for consideration’ is a necessary condition but not a sufficient condition for an ‘economic activity’.
Stage 2: The supply is made for the purpose of obtaining income therefrom (remuneration)
Where there is a direct or sufficient ‘link’ between the supplies made and the payments given, the activity is regarded as economic. The Court in Wakefield College  made a distinction between consideration and remuneration. Simply because a payment is received for a service provided does not itself mean that the activity is economic. For an activity to be regarded as economic it must be carried out for the purpose of obtaining income (remuneration) even if the charge is below cost.
We would suggest that all readers take an opportunity to refer to HMRC’s updated guidance which may be of interest to organisations in receipt of grant funding and charities supplying goods and/or services that are subsidised or supplied at cost. If there were any specific funding arrangements or transactions that you would like to discuss please do not hesitate to contact Stewart Henry at firstname.lastname@example.org or Laura Krickova at email@example.com
HMRC guidance can be viewed here.
We consider below cases that have been heard by the courts. Most involve charities and two, whilst not directly involving a registered charity, may be of interest.
COURT OF APPEAL
The Court of Appeal (CoA) has handed down its decision in the Royal Opera House Covent Garden Foundation (ROH). The case concerned the recovery of VAT incurred on ‘Production Costs’. These costs included fees for guest performers, sets, props, costumes etc. The claim made relates to VAT incurred totalling £532,069 between 1 June 2011 and 31 August 2012.
ROH is a charity staging highly acclaimed ballet and opera performances. ROH also makes supplies of catering. Customers attending performances can reserve a table at one of ROH’s various catering facilities.
Income generated from ROH’s ticket sales is exempt from VAT. Catering income is taxable. Generally speaking:
- VAT incurred on costs directly relating to exempt supplies is irrecoverable.
- VAT incurred on costs directly relating to taxable supplies is recoverable.
- VAT incurred that is not directly attributable to a specific supply or activity (usually overhead costs) falls to be apportioned and is recovered in part.
To determine the recovery of VAT incurred on costs it is necessary to establish for what purpose the expense has been incurred. The Court of Justice of the European Union (CJEU) has established that for costs to be used for the purposes of an onward supply there must be a ‘direct and immediate link’ between them.
In ROH it was HMRC’s position that the only ‘direct and immediate link’ of the Production Costs was with the sale of tickets and other supplies associated with productions (such as programme sales).
ROH argued that VAT incurred on its Production Costs also related to supplies of catering, on the basis that the Production Costs functioned, partly, to attract customers to use the catering facilities. The effect of this being that an increased proportion of VAT incurred on Production Costs was recoverable.
The question to be decided before the First Tier Tribunal (FTT) was by reference to what income streams should VAT incurred on Production Costs be recovered (ROH used the standard partial exemption method to calculate its input VAT recovery but triggered the Standard Method Override [SMO] which required it to calculate VAT recovery based on use).
ROH succeeded at the FTT in part (the FTT found there was a direct and immediate link to catering supplies, production specific commercial venue hires and shop sales of recordings of ROH productions). HMRC appealed the FTT’s decision in respect of catering supplies only. The Upper Tribunal (UT) set aside the FTT’s decision and exercised its power to re-make the decision. The UT rejected ROH’s submission that a ‘direct and immediate link’ was established because the Production Costs were incurred to attract customers to both attend the performances and use the catering facilities. The UT commented, “The fact that the Production Costs ‘enabled’ the ROH to make the Catering Supplies by attracting customers who bought tickets to the opera or ballet [to] partake of the Catering Supplies is not sufficient to establish a direct and immediate link.” The UT accepted HMRC’s contention that the link between the Production Costs and the catering supplies was no more than indirect.
The ROH appealed the decision of the UT on the basis that it had applied the wrong approach to the application of the ‘direct and immediate link’ test. The COA upheld the UT’s decision; however, the judgment provides an interesting examination of case law in this area. The COA noted the CJEU ruling in Sveda, which ROH relied on in support of its argument.
The CJEU ruled in Sveda that VAT incurred on the costs of constructing a recreational path (for which it received funding on the condition that the path would be free to access by members of the public) was recoverable on the basis that there was a ‘direct and immediate link’ to Sveda’s taxable activity of catering and retail supplies made along the path. The Advocate General commented that the ‘direct and immediate link’ would not exist in this case if either: the public were charged to access the path and such supplies were exempt (this is because the ‘direct and immediate link’ would be to exempt supplies) or if Sveda’s primary use of the path was for non-economic activity.
Interestingly, the COA briefly contemplated a scenario whereby ROH’s tickets to performances were free of charge. In such a situation, it may be arguable (based on Sveda) that a ‘direct and immediate link’ existed between the Production Costs and the catering supplies. Perhaps suggesting that full recovery of VAT incurred on Production Costs could be possible in this circumstance.
Constable VAT comment: The ROH case demonstrates just how complicated attributing VAT incurred by a charity can be, and how difficult the ‘direct and immediate link’ test can be to satisfy and interpret. In many cases charities and HMRC are required to make an objective judgment based on the facts relating to the circumstances at hand, unfortunately, charities and HMRC do not always reach the same conclusion and opinions differ.
An appeal by The Lilias Graham Trust (LGT) concerned whether its supplies are VAT exempt by virtue of their close association with a supply of welfare for children. LGT is a registered charity which operates a residential assessment centre where it assesses the parenting capabilities of those referred to it by a Local Authority (LA). LGT charges a fee to the referring LA. The First-tier Tribunal (FTT) previously held that such supplies are VAT exempt as they relate directly to supplies of welfare services for children. Whilst accepting that part of its service is VAT exempt welfare, LGT argued that the supply of accommodation or catering is specifically excluded from VAT exemption and should be taxed at the standard rate.
This may seem an unusual perspective; however, LAs and other public bodies can often recover VAT incurred in delivering their statutory duties (non-business activities), despite not making taxable supplies. A taxable supply by LGT would allow it to recover VAT incurred on costs directly associated with making those taxable supplies. Increased taxable supplies would be beneficial when calculating the recovery of VAT incurred on costs that cannot be directly attributed to a specific activity or supply, general overhead expenses following the VAT partial exemption rules.
LGT’s appeal to the UT was on the grounds that the FTT was wrong to conclude that the supplies of accommodation are ancillary to a supply of welfare. LGT had incurred a large amount of VAT on costs relating to these supplies and in seeking to agree that these supplies were taxable LGT hoped to secure a right to input VAT recovery in relation to these supplies to LA’s. The UK VAT legislation states that the VAT exemption for welfare does not apply to accommodation or catering “… except where it is ancillary to the provision of care, treatment or instruction.”
LGT argued that it was not necessary to consider whether there was a single, mixed, or composite supply for the purposes of the exclusion from VAT exemption. There was no doubt that LGT was supplying accommodation and catering, and that the finding that such supplies formed part of a larger supply did not preclude the different elements of that composite supply attracting different rates of VAT.
HMRC suggested that the FTT was correct to conclude that there is a single supply made by LGT to the LAs which should be correctly regarded as VAT exempt as a supply of welfare services. Therefore, there is no need to consider the exclusion from exemption for supplies of accommodation and catering as there is no supply of these services; there is a single supply of welfare services.
Considering the nature of single, multiple, and composite supplies, the Tribunal concluded that the purpose of the exclusion from exemption is to prevent supplies of accommodation being treated as VAT exempt when, in reality, those supplies are part of a main taxable supply. In the present case, the Upper Tribunal held that the FTT was correct to conclude that the supplies of accommodation and catering are ancillary to the supply of welfare services. The entire purpose of LGT’s services was to ensure the welfare of children and their parents, which included providing accommodation and food.
Constable VAT Comment: The argument mounted by LGT is complex and revolves around European caselaw. Readers who have a particular interest in the composite/multiple/single supply issue may wish to read the judgment in detail alongside key cases such as Card Protection Plan and French Undertakers. Ultimately, the Tribunal found that LGT was supplying welfare services to local authorities, supplies of associated accommodation were ancillary and facilitative to these supplies of VAT exempt welfare services.
The Upper Tribunal has overturned two decisions of the First tier Tribunal in circumstances where bodies which did not have charitable status may be able to treat as VAT exempt supplies of daycare services. These decisions were upheld by the Court of Appeal and the Supreme Court refused the taxpayers leave to appeal.
In the cases of Learning Centre (Romford) Limited and LIFE Services Limited the issue to be decided was whether supplies of daycare services could be treated as VAT exempt supplies even though the tests for VAT exemption were not strictly met.
The position can be briefly summarised as follows:
- Supplies of daycare services are VAT exempt welfare services if supplied by a charity or public body, regardless of whether the services are regulated by the CQC.
- If the daycare services are supplied by an organisation that is not a charity (the law refers to a state-regulated private welfare institution or agency, but this may apply to a CIC that does not have charitable status or a wholly owned trading subsidiary of a charity) and the services are not regulated by the CQC, the supplies are taxable.
The position is interesting because, basically, daycare services are not regulated in England or Wales, but they are in Scotland. This means that, potentially, commercial providers of daycare services in England and Wales are at a disadvantage when competing to supply services with charities, public bodies, or Scottish private businesses because they are obliged to VAT register and charge VAT if the value of taxable supplies exceeds the compulsory VAT registration threshold. Similarly, a Scottish supplier of daycare services does not have an opportunity to make its supplies taxable. A Scottish charity could not form a trading subsidiary to carry out the activities, and make taxable supplies, because daycare services are regulated in Scotland, regardless of the status of the supplier.
The First tier Tribunal decided in both cases (the cases were heard independently at this stage) that VAT exemption did apply to these supplies of services. This was based on ‘fiscal neutrality’ (LIFE Services Limited) and the inequality between Scottish and English VAT treatment. The Upper Tribunal reversed the decision in LIFE and the Scottish difference point was considered in a combined appeal of both cases to the Upper Tribunal which found in HMRC’s favour. The Court of Appeal has upheld the decision of the Upper Tribunal.
This is interesting because:
- There may be businesses that are not VAT registered that perhaps should be.
- There are likely to be organisations that are VAT registered but that are treating these supplies as VAT exempt.
- There may be an opportunity for charity to form a CIC or trading subsidiary to deliver these supplies and generate taxable income, and a right to reclaim VAT incurred on associated costs.
- If the customer is a local authority there may not be a problem if it can reclaim any VAT charged; however, the application of penalties for VAT accounting errors or a belated VAT registration may be an issue.
- One problem already identified is if the local authority or clinical commissioning groups wish to promote the use of Personal Budgets and Direct Payments. If a service user with a Personal Budget purchases day care services using a Direct Payment that service may be 20% more expensive for the service user because they will not be able to recover any VAT charged by the supplier. If the daycare service is commissioned by the local authority, we would usually expect them to be able to reclaim the VAT charged.
There may be a wider application to all non-regulated services delivered by organisations such as CIC’s and commercial providers other than daycare. A link to HMRC’s brief released after the decision is here.
FIRST TIER TRIBUNAL
This case concerns City YMCA London (CYL), a registered charity, that appealed HMRC’s classification of the VAT liability of supplies of services made by CYL to young people of hostel accommodation in return for payment.
As with many VAT cases, the position is not straightforward and can be complicated. In late 2010 CYL lost its ‘supporting people’ grant funding which meant that it would be supplying minimal welfare services.
To continue its support of those in need CYL makes a charge for its services, which consist primarily of accommodation and advice. Each individual resident is responsible for paying their room fee; however, this is most likely met by Housing Benefit, Universal Credit or Disability allowance.
The decision helpfully sets out the chain of events that followed after CYL lost its ‘supporting people’ funding. These can be broadly summarised as follows:
- January 2011 – CYL writes to HMRC seeking clarification of the VAT liability of its supplies moving forward now it is not receiving the ‘supporting people’ grant.
- March 2011 – HMRC confirms CYL’s supplies of accommodation and general advice was subject to VAT at the standard rate. The charity applied the 28-day rule which allows it to charge VAT at a reduced value to residents for stays over 4 weeks.
- September 2014 – HMRC carries out a routine VAT compliance visit to verify the charity’s VAT accounting records, specifically ensuring that the 28-day rules were being correctly applied.
- August 2017 – HMRC conducts a VAT compliance inspection which is followed by a letter advising that its supplies are VAT exempt supplies of welfare.
- October 2017 – HMRC revises its position and confirms that the charity’s supplies are standard rated as CYL is supplying sleeping accommodation and is “a similar establishment” to a hotel or boarding house.
- October 2018 – HMRC writes to CYL requesting more information about the services it supplies, whilst advising that HMRC did not now consider that it met the ‘hotel like’ accommodation criteria which (potentially) may not allow the charity to account for a reduced rate of VAT for stays for a continuous period of more than four weeks.
- January 2019 – HMRC writes to the charity and advises that its supplies are VAT exempt, not of welfare but of land (accommodation).
- March 2019 – HMRC writes to CYL reversing its decision of 2 months earlier and advises that the charity’s supplies are standard rated supplies of land (accommodation) and are specifically excluded from exemption. The charity’s supplies are not ‘hotel like’ and it cannot take advantage of the reduced rate where a young person stays for a continuous period of more than four weeks.
The benefit of the 28-day rule is that, provided certain conditions are met, including the provision of sleeping accommodation in hotels, inns, boarding houses, and similar establishments is that from the 29th day of the stay VAT is only due on meals, drinks, service charges and other facilities provided apart from the right to occupy the accommodation. The value of the accommodation is excluded from any calculation to determine output VAT due.
HMRC confirmed that the new ruling would take effect from 1 March 2019, there would be no VAT assessments raised for the incorrect application of ‘the previously under declared VAT’ under the long stay rules.
CYL sought an independent HMRC review of this final decision. The charity is advised by a letter dated 18 July 2019 that the March 2019 decision is upheld. This led to CYL’s appeal to the Tribunal.
The technical points to be considered were as follows:
- Is the charity’s supply one of a ‘licence to occupy land’ and a VAT exempt supply?
- If the charity’s supply is initially held to be a VAT exempt ‘licence to occupy land’, does the exclusion from VAT exemption as ‘the provision in an hotel, inn, boarding house or similar establishment of sleeping accommodation or of accommodation in rooms which are provided in conjunction with sleeping accommodation or for the purpose of a supply of catering’ apply?
In practical terms if a) above applies, the charity does not have to account for output VAT on supplies made/income received and it may be unable to reclaim VAT incurred on directly related costs. If b) above is correct, and CYL’s supplies are excluded from exemption on the basis that it is a ‘similar establishment’ to a hotel etc then it can reclaim in full VAT incurred that directly relates to making these supplies, and account for VAT on a reduced sum received because most of its residents stay for over 28 days.
HMRC’s preferred analysis is that the charity’s supply is one of a range of facilities (sleeping accommodation, access to communal facilities [kitchens, lounges] and oversight and control, signposting etc). As such, the charity’s supplies are standard rated, and it does not meet the ‘similar establishment’ to a hotel test to allow it to apply the reduced rate for long stays.
The Tribunal found that the preponderant element of the supply is the provision of sleeping accommodation. Any other facilities or services supplied are ancillary and provided while making the main supply of accommodation. The commercial and economic reality is that the supply is of a bedroom which characterises the VAT liability of the supply.
The second point is whether CYL is a ‘similar establishment’ to a hotel, boarding house etc. The Tribunal found that the charity’s supply is by a ‘similar establishment of sleeping accommodation’ because its intended purpose is providing temporary accommodation to homeless young people. In particular, the Tribunal noted that the temporary nature of the accommodation provided sets CYL’s supplies apart from VAT exempt long-term lettings of residential accommodation. Therefore, the charity’s supply is like the provision in the hotel sector.
Constable VAT comment: This is an interesting case, and it remains to be seen whether HMRC will lodge an appeal to the Upper Tribunal. A decision of the First-tier Tribunal is only binding on the parties involved and does not set a wider precedent. The decision demonstrates the benefit to CYL of clarifying the VAT liability of its supplies with HMRC in 2011. If any taxpayer submits a non-statutory clearance application to HMRC then, provided full facts are provided, HMRC are bound by its decision and cannot take retrospective action. If any business desires certainty as to the correct VAT liability of its supplies, and where there are potentially different interpretations, we would recommend pro-actively liaising with HMRC. Unfortunately, HMRC may refuse to give an opinion in all cases but an approach to HMRC is something that should be considered. The decision also emphasises how difficult it can be to agree the VAT liability of a supply, bearing in mind HMRC changed its opinion a number of times.
This case concerned Step by Step (SBS), a charity registered in Northern Ireland and with a UK VAT registration. It registered for VAT in 2011 but applied for that registration to be cancelled on 20 February 2018 on the basis that it did not make any taxable supplies. HMRC refused this VAT deregistration application, believing that SBS made a combination of outside the scope supplies of grant-funded vocational training and taxable supplies of catering, by virtue of which its VAT registration was required.
SBS supplies training services under an agreement with Southern Regional College (SRC). It provides work-based education and training through the operation of a restaurant. SBS applied to de-register for VAT on the grounds that it was making exclusively VAT exempt supplies of education and vocational training. It felt that its supplies from its restaurant were ancillary to the overall VAT exempt business activity of SBS and that VAT deregistration was appropriate.
HMRC suggested that, as the education provided by SBS is grant-funded, though not ultimately government funded, it is not a supply made in the course or furtherance of a business activity and is therefore outside the scope of VAT. HMRC claimed that, as there was no business supply of education arising, the supplies of the restaurant could not be viewed as ancillary or “closely related” to such a supply and, as such, the supplies made from the restaurant represent taxable supplies of catering.
Following the case of Colchester Institute, the Upper Tribunal found that the provision of education and vocational training in exchange for the receipt of grant funding is capable of being a “supply for consideration”. In this light, the Tribunal held that SBS’s supplies to SRC were VAT exempt supplies of education and considered whether the supplies of the restaurant were ancillary or “closely linked” to the overall activity.
Considering the criteria set out in Brockenhurt College, the Tribunal held that the supplies of the restaurant were sufficiently closely related to the overall activities of SBS which it had already ruled to be VAT exempt. Therefore, it held that SBS makes exclusively VAT exempt supplies. Accordingly, the appeal is allowed and the decision to refuse to cancel the VAT registration is quashed. HMRC shall re-make the decision.
Constable VAT Comment: It seems that in the light of the Colchester Institute decision, the provision of education and vocational training in exchange for grant-funding could now be regarded, by default, as a business activity (a supply in exchange for consideration) albeit that consideration is provided by a third party.
Following the judgment in Brockenhurst College, certain educational bodies are entitled to treat certain supplies to the general public as being made in the course of education or vocational training, usually rendering them VAT exempt supplies. HMRC are likely to apply the judgment in the case to other cases where the facts similarly indicate that the services are not being provided in competition with commercial enterprises. This will be the case where the services are not offered to the general public through advertising, including over the internet, and the costs of providing the supplies to the general public clearly exceeds any income generated from that activity.
Subsequent to the decision in Colchester Institute HMRC issued Brief 8 (2021) which can be found here.
We would also take this opportunity to remind readers that VAT registration does give a degree of protection in the event VAT accounting errors occur. If a charity mistakenly classifies a supply as zero-rated or VAT exempt, and HMRC challenges that on the basis that the supply is standard-rated and VAT at 20% should have been accounted for on income received, there is a statutory 4-year time limit in which the error can be corrected. A mistake made in 2017 cannot be adjusted now, the only exception is in cases of fraud. However, if a charity is not VAT registered, the 4-year capping rules do not apply. If a charity is not currently VAT registered but should have been VAT registered some time ago because it is making taxable supplies, a retroactive VAT registration will be required. This will usually involve the completion of a long-period first VAT return spanning several years. HMRC can also apply a belated notification penalty for a late VAT registration.
Charities can register for VAT on a voluntary basis even if the value of taxable supplies made is below the compulsory VAT registration threshold, although a voluntary VAT registration may need to be balanced against the administrative burden of maintaining VAT accounting records, submitting VAT returns etc.
Please note that this newsletter is intended to provide a general overview of the subject. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this blog post. Specialist VAT advice should always be sought in relation to your particular circumstance.