A question which is frequently put forward to the Courts and Tribunals is whether an activity is a business activity for VAT purposes. Whilst this is an issue often encountered by charities this can affect all businesses.
Only activities that are regarded as business activities fall within the scope of VAT. VAT incurred on costs relating to non-business activities is irrecoverable. Therefore, identifying the correct liability of activities/income is vital to determining the VAT recovery position on associated costs.
Historically, in deciding whether an activity is a business activity, HMRC has applied the ‘business test’. The business test derived from the cases of Morrison’s Academy and Lord Fisher and consists of the following six questions. These act as a guide although the absence of one common attribute of ordinary businesses (e.g. the pursuit of profit) does not necessarily mean that the activity is not a business. The criteria are not, therefore, conclusive in every case.
- Is the activity a ‘serious undertaking earnestly pursued’ or a ‘serious occupation not necessarily confined to commercial or profit making undertakings’?
- Is the activity an occupation or function actively pursued with reasonable or recognisable continuity?
- Does the activity have a certain measure of substance as measured by the value of taxable supplies made?
- Is the activity conducted in a regular manner and on sound recognised business principles?
- Is the activity predominantly concerned with the making of taxable supplies to customers for consideration?
- Are the taxable supplies of a kind which are commonly made by those who seek to profit by them?
HMRC has previously said that this test (dating back to 1978) has been superseded and the recent Court of Appeal decision in Longridge on the Thames appeared to confirm this. In the case of Longridge, the Court of Appeal clarified that the test to determine whether an economic activity is carried on is whether there is a direct link between the payment made and the supply received. If there is no direct link between the service and the payment received there will not be an economic activity for VAT purposes. The fact that the supplier does not seek to make a profit is also irrelevant.
Interestingly, in the recent case of Gravel Road Records Ltd HMRC did not rely on the most recent litigation in Longridge. HMRC’s submissions included detailed consideration of the business test derived in Morrison’s Academy and Lord Fisher. The use of the ‘old’ test in this case suggests that HMRC believe that this test is still relevant and this is something charities and businesses should bear in mind when considering whether an activity is for business purposes. The appellant in this case was not a charity.
HMRC de-registered Gravel Road Records Ltd for VAT and reduced VAT repayment claims to nil on the basis that no business activities had taken place during the period of VAT registration. Gravel Road Records had no entitlement to recover VAT incurred. Most of the VAT incurred related to the construction of a recording studio and no taxable supplies had been made. The construction was financed almost entirely by a third party as an investment. The recording studio was situated in industrial premises. There was a downturn in the music industry and the business failed to attract artists. Two clients were found but construction delays led to them finding alternative studios. The Tribunal found that at all times Gravel Road Records intended to carry on a commercial business activity and was intending to make taxable supplies. Therefore, the appeal was allowed.
These cases act as a helpful reminder to all businesses that consideration should be given to both tests when reviewing potential contracts for goods and services.
If you would like to discuss any of the services CVC can offer to review activities undertaken please contact us on 01206321029 or info@ukvatadvice.com and one of our consultants will be happy to speak to you.