Is it a grant or payment for a taxable supply? HMRC replaces its VAT guidance

One of the more complex tax issues charities face is working out whether the funding they receive – be it from a grant-making foundation or a public authority – is a grant or a payment for services for which they need to charge VAT. Getting it wrong, either one way or the other, can be expensive.

If it turns out that the funding was a grant but the charity had been expecting to make a taxable supply, the charity will lose its ability to reclaim VAT on the goods and services it bought to enable it to carry out the funded project. Alternatively, if the funding was conceived as a grant but was in fact for a taxable supply, the charity will be left owing an unwelcome sum to HMRC. On the other side of the equation, grant-makers may discover that, in addition to funding a project they consider worthy of their bounty, they may be contractually bound to give a further sum of money to pay for the charity's VAT exposure.

HMRC first published guidance on this thorny issue in Spring 2016. Following what appears to have been a lengthy consultation with The Charities Tax Group, the revised guidance was released in January 2018. The new version is more detailed than the original and considers charitable grants specifically, as distinct from other types of grants (for example those made by Local Authorities).

The main reason why the law in this area is so difficult is that the terms used in the legislation are unhelpfully vague(1). For a VAT liability to arise, a recipient of funding must be making a supply of services 'for' the payment and there must be a 'direct link' between the payment and the supply(2). There is a string of cases on what it means for a supply to be made for payment and what does and doesn't constitute a direct link, from the European court as well as in the UK courts and tribunals. These cases are not always easy to reconcile.

It is from this string of cases (or, at least, some of them) that HMRC has attempted to draw out underlying principles and put together its guidance.

It is not the aim of this article to offer a comprehensive overview of the underlying law on this topic but rather to provide an outline and opinion of the new guidance.

What is in the guidance?

It consists of about 30 webpages. You can find the contents page here.

The guidance sets out:
• Factors indicating the payment is a grant;
• Factors indicating the payment is consideration for a supply;
• Factors that are neutral.

We'll now briefly look at each.

Factors indicating a grant:

• the funding recipient carries out its own charitable aims with the assistance of the money, which is given with no expectation of direct benefit in return;
• the funder will not attempt to control how the money is spent beyond seeing that it is properly managed. Any monitoring is no more than simply ensuring the payments are spent appropriately;
• there is a 'clawback' provision in the agreement, allowing the funder to reclaim its money in circumstances where, say, not all of it was spent;
• if the funding is withdrawn, there is no legal redress for the recipient to have it reinstated.

Factors indicating a payment for a taxable supply:

• the funder initiates the agreement: if the funder is seeking services in return for its payment, this indicates the payment is consideration for supplies;
• the funding recipient undertakes outsourced activities on behalf of the funder, where the services involved are ones ordinarily provided by the funder;
• if the funding is withdrawn, there is legal redress for the recipient to have it reinstated or claim compensation.

Factors that are neutral:

• the payment is described as a 'grant' in the contract and correspondence;
• the level of detail in the funding agreement: it is wrong to say that the more detail there is, the more likely it is that the funding amounts to payment for a taxable supply.

The bullet point lists are at the heart of the guidance, but readers must be cautious when referring to them. As the guidance itself points out: "it is not simply a matter of 'indicators for' exceeding 'indicators against', a balanced view needs to be formed taking all the applicable indicators into account. You must consider the economic reality not just the contractual terms."

Is the guidance useful?

On the whole, yes. The bullet points are a reasonable summary of the principles arising out of the case law and, by providing a précis of the cases concerned, HMRC gives readers an opportunity to understand the circumstances in which those principles were formulated.

However, this endorsement comes with a significant caveat. There is a danger that trustees entering into a funding agreement whose VAT status is unclear will rely on the guidance to determine whether or not the arrangement will attract a VAT liability, only to discover, later on, that HMRC disagrees with their analysis and would like some money. Although courts and tribunals have been known to take account of HMRC guidance, such guidance is not legally binding and it is inevitable that, on a subject as nuanced as this, some detail has been sacrificed for the sake of brevity and readability.

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(1) Though perhaps unavoidably, given they derive from an EU Directive.
(2) Other factors must also be present, but these tend to be the sticking points when it comes to deciding whether a payment is a grant that is outside the scope of the VAT regime.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances. © Farrer & Co LLP, February 2018.