Tax – it doesn’t have to be taxing

27 Nov 2020

tax

Tax can be a complex area and getting it wrong can be costly. One of the trickiest areas for charities is VAT.

Charities are able to claim a number of valuable tax reliefs but knowing the rules can make the difference between a project being financially viable or being a financial liability. In this blog our experts aim to provide clarification on this complex area.

Firstly, are all non-profit organisations charities?

To be considered as a charity an organisation must have secured charitable status. Not all non-profit making bodies have charitable status and are therefore not charities.

To claim charity VAT reliefs in the UK, organisations must now meet the following conditions;

  • Charities must be based in the
    • UK,
    • Isle of Man
    • or an EU member state
  • Charities must be established for charitable purposes only
  • Charities must be registered with the Charity Commission or corresponding regulator
  • Charities must be run by ‘fit and proper persons’
  • Charities must be recognised by HMRC.

If your charity is not currently recognised by HMRC, it is possible to apply for recognition online. To demonstrate recognition of charitable status simply quote your HMRC recognition reference.

What are the implications of VAT for charities?

In essence, VAT is a tax on consumer expenditure. It’s collected on business transactions, imports and acquisitions. A charity will pay VAT on all standard-rated or reduced-rated goods and services they buy from VAT-registered businesses. VAT-registered businesses can sell certain goods and services to charities at the reduced rate or zero rate.

Do all charities need to register for VAT?

Any business – including a charity or its trading subsidiary – that makes taxable sales in excess of the VAT registration threshold must register for VAT.

Taxable sales are classified as business transactions that are liable to VAT at the standard, reduced or zero rate. If the level of income from taxable sales exceeds the VAT registration threshold you will need to register the charity for VAT. This is not optional, the organisation can be penalised for failing to register.

How does VAT affect charities?

Charities receive income from numerous sources; some of the sources may be liable to VAT if the charity is VAT registered. However, charities will be able to claim relief from VAT on some of the goods and services they buy, regardless of whether the charity is registered for VAT.

It is a confusing area, as although charities can claim tax relief if they’re unregistered,  many of the goods and services that charities buy will be subject to VAT, regardless of whether the charity is registered for VAT. But importantly, charities that are VAT registered may be able to reclaim some of the VAT they’re charged from HMRC.

What VAT can a charity reclaim?

A charity needs to consider the VAT on its expenses in 3 stages.

Firstly, non-business (outside the scope)

A charity cannot reclaim any VAT charged on purchases directly relating to non-business activities. Once a VAT-registered charity has determined which of its activities are non-business it will also have to consider how much of the VAT on its general expenses (such as telephone and electricity) relate to those activities. The charity will not be able to reclaim the proportion of VAT that relates to non-business activities.

Secondly, taxable sales

A VAT-registered charity can reclaim all the input tax charged on purchases directly relating to taxable goods or services. Only a charity that is VAT registered will be able to recover the VAT it is charged on standard-rated or reduced-rated goods it buys from VAT-registered businesses.

Thirdly, VAT exempt activities

A VAT-registered charity isn’t able to reclaim the input tax it has been charged on purchases relating to exempt activities – unless these are below a set level (known as the de minimis limit). If the total exempt input tax is below the de minimis limit, then the charity can reclaim it.

What VAT must charities charge?

A VAT-registered charity must charge VAT on all the standard-rated and reduced-rated goods and services. The charity does not charge VAT on any income from non-business, zero-rated or exempt sales.

Best practices when accounting for VAT

At the end of a set time period – normally every three months – a VAT-registered charity will be required to complete a VAT return. This VAT return details the VAT the charity has charged on sales of standard-rated and reduced-rated goods and services, and the VAT it has paid on goods and services it has bought that relate to taxable sales.

If the calculated VAT on the charity’s sales equates to more than the VAT on its purchases the charity must pay the excess to HMRC. However if the VAT on purchases is more than the VAT due on the sales the charity can reclaim the difference from HMRC.

If you would like independent advice on your charity’s finances please do contact a member of our team.

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