The UK Supreme Court released a decision this week in a case brought by Frank A Smart & Son Limited, which may have the potential to restrict VAT recovery by charities on fundraising costs. Not for profit entities are strongly encouraged to review their VAT recovery position as a result of this and the recent European Court judgment in University of Cambridge.
Earlier this month, the Court of Justice of the European Union (CJEU) found in the University of Cambridge case that investment management costs of a charity operating endowment and similar funds are not an overhead cost. (See BDO’s article from 5 July for more details). Instead, the CJEU decided those costs are wholly attributable to a non-business activity of raising the funds held in these investments, meaning that the VAT incurred cannot be recovered at all, even if the funds raised are used in generating VAT bearing income.
The latest case related to recovery VAT of just over £1m incurred on the purchase of Single Farm Payment units by a farming business to generate EU subsidy payments. The business took the view that the expenditure was wholly related to its farming operations (in particular to future plans to use the subsidies to buy more land, construct more farm buildings and create a new windfarm on the site) and therefore the VAT was recoverable. HMRC refused the claim, arguing that the activity was a separate investment operation and therefore the VAT was not directly related to taxable supplies even if the funds raised supported its farming activities. This is a very similar argument to the position HMRC took in Cambridge.
The Supreme Court has, in this case, accepted that the VAT incurred was wholly related to the farming business. However, in doing so, it has made some comments on the Cambridge judgment and a number of earlier CJEU decisions which may be unhelpful for charities’ VAT recovery on fund raising costs.
The Supreme Court judgment
The Supreme Court has decided that, where expenditure is incurred that amounts to a ‘cost component’ of a ‘downstream’ taxable activity, the VAT should be recoverable. This can arise in respect of fundraising, where there is clear objective evidence that the funds raised are linked with actual taxable supplies made, including where costs are incurred in advance of a taxable supply.
The Supreme Court has reinforced earlier CJEU decisions by explicitly confirming that VAT incurred related to a sale of shares (VAT exempt) is not automatically irrecoverable where the shares are sold to generate funds used to make taxable sales. HMRC has long disagreed with this approach but has previously accepted that VAT related to the issuing of new shares or in raising other finance to support taxable activities is recoverable.
The Supreme Court in Frank A Smart has commented that Cambridge fell outside of this principle as the funds raised from endowment funds were used to subsidise the prices charged for charitable activities, such as education. Therefore the costs were not ‘cost components’ of a downstream taxable activity and were not recoverable.
The judges also said that it is vital for the claimant to retain evidence to support the reasoning for generating funds in order to satisfy HMRC there is a direct link to a taxable activity, and suggested that HMRC should, at a later date, check that the costs were not subsequently diverted to an exempt or non-economic use. If they have, a self-supply charge may be payable to HMRC to offset the VAT claimed.
What does the Frank A Smart judgment mean for charities?
The recent CJEU and Supreme Court judgments may mean that the guidance issued in 2005 by HMRC following the Church Of England Children’s Society decision will be revised. The 2005 guidance confirmed that where donated funds supported taxable activities, charities could treat a proportion of the VAT incurred as recoverable. The Cambridge judgment is directly concerned only with costs incurred on endowment and similar funds.
At present, charities usually refer to HMRC’s guidance on entitlement to recover VAT incurred that partly relates to donated funds and grants used to support their taxable activities.
There is, however, a large body of case-law related to this seemingly simple area of VAT, and other CJEU cases have suggested different approaches to identifying input VAT that relates to taxable supplies, such as Sveda and Kretztechnik.
HMRC’s response to these latest judgments is therefore likely to provide greater certainty for charities but in the meantime charities may wish to proactively review their VAT treatment and of fundraising and investment costs.
For help and advice on any VAT issue for not-for-profit organisations, please contact Wayne Neale or Glyn Woodhouse.