Q&A: Charity tax and VAT
Bill Lewis, The Guardian
Surely charities don’t have to pay taxes?
This is a common myth, and while charities do enjoy some tax and VAT reliefs, they are also liable for a number of tax and VAT charges.
What do they not pay tax on?
Profits made from carrying out their primary charitable purposes or from activities carried out by their beneficiaries, rents from land and buildings, bank interest, dividends, certain fundraising events, gItifts and the sale of donated goods are all exempt from income and corporation tax. And provided that any gains are applied for charitable purposes then they are also exempt from capital gains tax.
So what do they pay tax on?
A number of activities can result in a tax bill, for example sponsorship payments from corporate sponsors that require the advertisement of their name and logo. The sale of new goods that are not sold as part of primary charitable purposes and land development gains are also liable to tax.
Are there any smart ways for charities to avoid tax?
Many charities run their otherwise taxable activity through a wholly owned trading subsidiary. The subsidiary then gives its profits to the parent charity under gift aid, and thus avoids paying any tax on these profits. It is worth mentioning that this is standard practice rather than an elaborate avoidance scheme and as such is readily accepted by HM Revenue & Customs (HMRC).
Is VAT straightforward?
Sadly not. Charity VAT is one of the more complicated areas of VAT, which is a great shame given that many charities are operated by unpaid volunteers who have to administer the complex rules.
Can you explain what these rules are?
Basically, charities are treated just like any other organisation. If they are engaged in VAT-taxable activities that exceed HMRC’s compulsory VAT registration threshold (currently £68,000 turnover over a 12-month period) then they have to register for VAT, and charge VAT where appropriate. However, many charities do not have to register for VAT because their income comes either from grant funding (and so is outside the scope of the VAT system) or is exempted from VAT under EU law.
What are typical examples of VAT-exempt income for a charity?
Typically, we are looking at fees received for welfare or educational services here. Fees received for the care, treatment or instruction of children, the elderly, the sick and the disabled are exempt from VAT. Likewise, educational services can be exempt from VAT provided that any profits received from the sale of the education are ringfenced and only used to help future paid provision of educational services.
Is there a downside?
Yes. Under EU VAT rules, a supplier can only recover VAT on their costs if they make VAT-taxable sales, ie charge VAT at the standard rate of VAT (currently 15%), the reduced rate (5%) or the zero rate. The rules do not allow organisations that make VAT-exempt sales to recover VAT incurred on the cost of making those sales. This can put charities at a disadvantage compared to many commercial businesses and is a huge bone of contention in the charity sector, with estimates of there being up to £0.5bn irrecoverable VAT.
What happens if a charity receives both VAT-taxable and VAT-exempt income? Can it still recover all the VAT on its costs?
In this case, the charity is what is called a partially exempt organisation. This broadly means it can reclaim the VAT incurred on the cost of making its VAT-taxable sales, cannot recover any VAT on the cost of making VAT-exempt sales, and can recover a proportion of the VAT incurred on its general overhead costs. This proportion can be calculated in many different ways.
If charities cannot always recover VAT on their costs, can they ever avoid paying VAT on those costs in the first place?
Yes, luckily there are a number of special rules in place that enable charities to buy certain goods and services at the zero rate of VAT, while other businesses would have to pay the standard rate.
Where a charity advertises in someone else’s time and space, eg in a newspaper, magazine, or on television, the cost of that advertisement is subject to the zero rate of VAT. This is of benefit to most charities.
There are also VAT-zero rates available, for example, for charity fundraising appeal packs, collection boxes, certain pin badges, and a whole raft of zero rates available for charities in the care sector connected with the purchase, adaptation and repair of appliances designed for disabled people, and similarly for vehicles designed or adapted for carrying disabled people.
Additionally, the construction of new buildings for many residential and certain non-business charitable purposes can be carried out at the zero rate of VAT. However, the rules here are also quite complicated and there have been a number of court cases grappling with whether a particular building should have been constructed at the zero rate or standard rate of VAT.
Does HMRC really take charities to court?
Yes, there are several court cases every year, though sometimes it’s the charity that takes HMRC to court. Perhaps the worst case in recent years involved Jeansfield Swifts, an organisation that provided football for inner-city children. HMRC said it had to pay VAT on the construction of its new clubhouse because it believed it was used for business purposes. The business in question involved charging the children a few pounds in match fees and the sale of light refreshments on match days. The charity won the case and HMRC was heavily criticised in court for its handling of the case. .
So, in summary, charities can often fall into VAT and tax traps because the rules are complicated and can then get fined or taken to court by HMRC?
Yes. The UK has the longest set of tax rules in the world, and the complex rules concerning charities are part of the reason for this.
Were there any changes announced to charity tax and VAT as part of last week’s pre-budget report?
The standard rate of VAT will return to 17.5% in January – that will affect everyone and not just charities. Otherwise, the government confirmed it is considering changing the rules for higher-rate tax relief and Gift Aid – this may result in more Gift Aid repayments to charities at the expense of higher-rate tax relief for the donor. The government also confirmed that it was revisiting its complex rules for ‘substantial donors’ – those who give at least £25,000 a year to a single charity – in order to make the rules less complex. This can only be good news for the sector.
Where can I get further advice?
It is strongly recommended that advice is sought from lawyers and accountants with specific charity expertise.
Otherwise, there are extensive free sources of information on the HMRC website, including a large section covering charities and donors: www.hmrc.gov.uk/charities-donors/index.htm. For general VAT guidance, the following publications can also be downloaded from the HMRC website: VAT Notice 701/1, Charities VAT Notice 701/58, Charity Advertising VAT Notice 701/7. Advice on VAT reliefs for disabled people can also be sought from the HMRC charities helpline: 0845 302 0203, or email enquiries to firstname.lastname@example.org. It is strongly recommended that advice from HMRC is always confirmed in writing to ensure there is no misunderstanding down the line.