Value Added Tax (VAT) is a familiar concept for most businesses, but for charities, it can be a complex part of financial management.
Charities are not automatically exempt from VAT. Like any other business, they must register with HM Revenue and Customs (HMRC) if their taxable business income exceeds £90,000 in a 12-month period, or if they expect their taxable business income to exceed this amount within the next 30 days.
As trustees and key finance personnel of charities, it’s important to understand the rules and regulations in respect of VAT, and to regularly check that the charity is not exceeding the VAT registration threshold.
Misunderstanding VAT and its impact on charities can lead to a lost opportunity to reclaim input VAT and also risk HMRC penalties if the charity fails to register on time.
What is considered “taxable business income”
For a charity to determine if it needs to register for VAT, the charity’s taxable business income needs to be calculated. This includes:
- Standard-rate supplies (20%)
- Reduced-rate supplies (5%)
- Zero-rate supplies (0%)
The calculation does not include income from activities that are:
- Exempt from VAT – for example, income generated from welfare services and educational activities
- Outside the Scope of VAT – for example, voluntary donations and grant funding, where nothing is given in return.
It’s important to understand that although a charity may perform activities that benefit the community or support its charitable goals, these activities can still be classified as business activities for VAT purposes.
HMRC applies a two-stage test to determine whether an activity qualifies as a business activity under VAT regulations:
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Stage 1: Is there a supply of goods and/or services for consideration?
If the charity provides goods and/or services and it receives payment in return, then there is a supply for consideration.
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Stage 2: Is the supply made for the purpose of obtaining income?
If the charity undertakes an activity with the intention of generating income, it is regarded as a business activity.
If the answer to both questions is ‘yes’, the charity is regarded to be conducting a business activity for VAT purposes.
However, certain charity-specific VAT rules and exemptions may still apply, which could result in some supplies being treated as exempt from VAT or outside the scope of VAT.
Ultimately, if the activity is deemed to be business for VAT purposes, this does not automatically mean that the charity needs to register for VAT; however, it does mean that the income generated from the business activity must be taken into consideration when determining whether the charity’s taxable business income exceeds the VAT threshold.
Common business activities undertaken by charities:
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Retail operations – for example, running a charity shop or café
Income generated from a shop or café that sells to the general public is typically classified as a business activity for VAT purposes.
This classification applies because it meets both conditions of the two-stage test mentioned earlier, even if the sales are intended to further the charitable objectives of the organisation.
Although income from retail operations is generally regarded as a business activity for VAT purposes, specific VAT exemptions may apply to charities. These exemptions can include the sale of donated goods and supplies related to welfare.
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Sponsorships
The key VAT question is whether the sponsor receives something in return for their payment.
If nothing is given in return and the charity provides minimal acknowledgement (not promotion), then the sponsorship is treated in the same way as a voluntary donation, and is outside the scope of VAT.
However, if the sponsor receives something of value in return (e.g. advertising or promotion), then the sponsorship will likely be seen as a taxable business activity by HMRC.
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Training sessions
Suppose a charity provides paid training courses to external organisations on a commercial basis and the charity is not an ‘eligible body’. In that case, this will generally be seen as a business activity for VAT purposes.
Further guidance on whether something is a business transaction can be found in section 4 of the VAT Notice 701/1.
VAT that a charity can reclaim
- Non-business (outside of the scope) activities – A charity cannot reclaim any VAT it is charged on purchases that directly relate to non-business (outside the scope) activities.
- Taxable activities – A VAT-registered charity can reclaim all the input tax it is charged on purchases which directly relate to taxable goods or services it sells.
- Exempt activities – A charity cannot normally reclaim input VAT directly attributable to exempt activities. However, as a charity you could incur input VAT on supplies that relate partially to exempt supplies and partially to taxable supplies. In that case, you have mixed activities, and the VAT must be apportioned in accordance with the partial exemption rules.
Partial exemption rules
As a charity, you may make taxable and exempt supplies, which means that partial exemption rules may apply.
When costs relate to both taxable and exempt activities, such as accountancy fees or utility costs, only a proportionate share of the input VAT can be reclaimed.
However, if the amount of exempt tax is minimal, the de minimis rules may allow the charity to fully recover the associated input tax.
Trading subsidiaries
As an option to keep things simple for a charity, you can establish a trading subsidiary company to manage the non-primary purpose business activities. The trading subsidiary is a not-for-profit entity that is fully subject to VAT. Of course, the subsidiary can choose to donate its profits to the parent charity.
Conclusion
We would always recommend that charities regularly review their income streams to ensure compliance with VAT regulations.
As trustees, you must differentiate between taxable, exempt, and non-business activities conducted by the charity and correctly apply the partial exemption rules where applicable. Seek professional guidance where necessary.
Furthermore, the charity could consider using a trading subsidiary where appropriate to manage VAT efficiently and protect charitable funds.
We are experts in VAT, and to learn more about our work with charities, visit our website here.