8 March 2018

HMRC update their guidance on grants - should you be recovering more VAT?

HMRC has updated guidance on VAT liability of grants and contracts but many organisations are under recovering VAT incurred on associated expenses

It has been widely published that HMRC has updated its guidance on the VAT liability of grants and contracts however it is not widely appreciated that a lot of organisations are under recovering the VAT they incur on associated expenses.

It can often be difficult to work out when the receipt of grant funding is outside the scope of VAT and when it is a payment for a supply of goods or services. Even when a funding agreement states that the payment is a grant, if there is a specific and measurable supply of goods or services the funding could be liable to VAT.  Equally  it could be exempt and result in the VAT on associated costs being blocked from recovery).

HMRC’s updated guidance goes some way to help charities (and their advisors) better determine whether the funding is a grant or a supply agreement. The guidance provides a list of indicators which have been taken from case law and which would normally be found in grants or supply contracts. The examples include:

Grant indicators

  • the funder will not attempt to control how the money is spent beyond ensuring the funds are properly managed.  Any monitoring should simply ensure the payments are spent appropriately;
  • the payment was made following a grant application process run by an organisation that regularly provides outside the scope grants, such as central or local government;
  • the recipient of the funding will set its own targets rather than the funder imposing specific targets

Contract indicators

  • the funder will attempt to control how the money is spent, by imposing specific targets in terms of quantity, quality, timeframes etc.  Any monitoring is more than simply ensuring the payments are spent properly and will ensure that specific supplies are made;
  • the supplier undertakes outsourced activities on behalf of the funder where the services provided are ones ordinarily provided by the funder - the supplier is acting as a subcontractor.  Examples include the provision of functions ordinarily undertaken by local authorities that they have a statutory duty to perform and would face sanctions if they did not happen;
  • each activity carried out by the funder gives rise to a specific and identifiable payment.  This is an agreed sum, either a single payment or a sum per activity i.e. the more work done, the greater the payment.  For this to happen there is probably a detailed recording system for timekeeping, outputs achieved etc.

HMRC summarise this guidance by stating “The principal factor to consider is if a specific supply is made to the funder or a third party in return for a payment. If so the payment is consideration for a supply, but if this direct link is not established then the payment can be treated as outside the scope of VAT.”

While this update may go some way to assist in determining whether an agreement is a grant or payment for a supply, it can still be a grey area  - especially when some agreements have the indicators of both grants and contracts. Where you have any doubts or you would like a second opinion Scott-Moncrieff’s VAT team have the expertise to assist you.

Recovering more VAT

It is common for grants to be received to fund the day-to-day running costs of an organisation. When an organisation is VAT registered and has non-business (free of charge) activities, it is often suggested that grants be used as a measure of the non-business activities for VAT recovery purposes.  In this case overhead grants are often included and recorded as non-business activities in the VAT recovery calculation.

However, if the overhead grant is used to fund all of the organisation's activities it is incorrect and distortive to include it in the VAT calculation as a measure of non-business activity.  In our experience overhead grants should normally be excluded from an organisation's business/non-business apportionment calculations which in turn can increase the value of recoverable VAT.

We have agreed this point with HMRC for several charity/not for profit organisations and this has resulted in additional repayments of VAT from HMRC .  In some cases we have gone back for four years.  It has also resulted in an improved VAT recovery position in future VAT periods.

Please contact us if your organisation performs a business/non-business calculation which includes overhead grants.  We can help you determine whether this practice is distorting the recovery of VAT and whether you may be able to improve your recovery of VAT.

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