UK: Spotlight On VAT

Last Updated: 20 June 2011
Article by Ian Stinson

Share the costs – but avoid the VAT?

Many charities and not-for-profit organisations are attempting to reduce establishment costs by setting up arrangements with other charities to share management costs such as finance, HR and estate management.

Unfortunately, the provision of administration services between members of the cost-sharing association might give rise to significant VAT costs under UK VAT law as HMRC has not adopted a VAT exemption available under EU VAT law.

Last summer, HMRC announced it would carry out a consultation with a view to implementing the cost-sharing VAT exemption already in place under EU law. In this year's Budget, it was announced only that the consultation was ongoing.

The exemption allows members of a costsharing association to buy and sell certain services between themselves free from VAT, thus reducing management costs without creating an irrecoverable VAT cost.

Because the cost-sharing exemption is a provision of the EU Principal VAT Directive, there is a strong argument that this has direct effect in the UK. Charities should therefore be entitled to rely on the EU rules even though there is no equivalent measure under UK VAT law. However, it may yet be some time before the cost-sharing VAT exemption is enacted in UK VAT legislation.

VAT recovery for academy schools – the hidden costs

New rules for independent academy schools will require claims to be submitted to HMRC to reclaim VAT on expenditure for non-business activities. This replaces the additional grant funding that academies previously received to compensate them for their irrecoverable VAT.

Subject to the Finance Bill receiving Royal Assent, the new VAT reclaim rules will come into force retrospectively from 1 April 2011, but as the previous VAT grant funding will continue until 31 August 2011, we understand that academies will be given the option to reclaim VAT under the new rules from 1 April and to repay the relevant grant funding.

Academies will need to review their VAT registration position as HMRC intends to treat academies the same as local authorities, which do not have a VAT registration turnover threshold. Those that are or become VAT registered, will submit VAT returns in the usual way in order to reclaim VAT on allowable expenditure. Those not required to register will need to submit special claims, similar to those submitted by local authorities, for a refund of VAT on their non-business activities.

The most significant financial impact is that academies may not be able to reclaim VAT on expenditure relating to their exempt business activities. Under the grant system academies would be compensated for all irrecoverable VAT, but under the 'normal' VAT recovery rules, VAT on expenditure relating to exempt activities (classroom and sports hall hire or adult education classes) would only be reclaimable if below a de minimis threshold level.

Academies will be required to itemise VAT costs and to attribute them to the separate activities that permit or disallow VAT recovery; they will also need to apportion general overhead costs and may suffer a partial VAT recovery disallowance on general overhead and property costs.

The change in rules will require academies to maintain detailed VAT accounting records and will involve them in potentially complex VAT refund claim calculations. We understand that detailed VAT guidance may be issued to academies affected by this change.

Charity buildings – change of use VAT charge

HMRC has updated its guidance on how charities must calculate the change of use VAT charge in respect of certain VAT-free buildings from 1 March 2011.

Under specific circumstances charities are able to claim zero-rating for the purchase or construction of any new building intended to be used solely for a "relevant charitable" or a "relevant residential" purpose, although HMRC does allow charities to ignore non-qualifying use if it is less than 5% of total use (previously 10%). If zero-rating is claimed, but the building (or part thereof) is subsequently put to a non-qualifying use within ten years of completion, the charity may be liable to pay a VAT charge on the non-qualifying use. The change of use charge can arise from a sale or lease of the building or from the way in which the building is physically used by the charity.

In December 2010 HMRC announced it was to simplify the way in which the change of use VAT charge should be calculated, as there were separate adjustment mechanisms in place depending on whether the charge arose out of a lease or sale, or from a change in qualifying occupational use by the charity.

In January this year HMRC issued an updated information sheet (04/11) detailing the revised adjustment mechanisms and confirming that the new adjustment mechanism will only apply to buildings completed on or after 1 March 2011, and also in respect of a change in use taking place on or after 1 March 2011.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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