Constable VAT & Charities Newsletter May 2015

12th May 2015

In this newsletter we cover:

  1. VAT cases
  2. VAT refund scheme for certain charities
  3. Penalties for errors
  4. Barter transactions
  5. Prompt payment discounts

Court of Justice of the European Union (CJEU)

Input tax recovery – free use of recreational path to attract visitors

Many charities receive funding which is outside the scope of VAT. Such funding may include grants from Central Government, Local Authorities, charitable trusts, supporter donations and legacies. There is no requirement to account for VAT on this income; however, the income received may be used to support business activities.

Juliane Kokott (an Advocate General at the Court of Justice of the European Union [CJEU]) has recently given her opinion in the Lithuanian case of Sveda UAB that free use of an asset, with an intention to generate taxable supplies, has a business purpose. The opinion of the AG is not final; however, it is often a good indication of what the CJEU will conclude. If this case is settled in the taxpayers favour it may have a significant impact on the sector, and HMRC UK VAT policy.

This opinion has not been translated into English; however, it is very interesting to note from the AG’s opinion that the UK Government submitted written observations to the court in July 2014 and attended the hearing on 4 February 2015. The level of HMRC resource devoted to a case involving a taxpayer in another Member State demonstrates that HMRC recognises the potential importance of the decision.

In 2012 Sveda established a recreational trail dedicated to Baltic mythology. It built infrastructure (roads, car parking) and facilities such as campsites, an information booth, observation platforms, stairs and footpaths. Costs were financed by a 90% grant from the Lithuanian National Agency of Payments to the Ministry of Agriculture. The terms of the grant provided Sveda must allow free public access to the trail. The issue of whether the funding received could represent consideration was not discussed. The question referred to the CJEU concerned the right to recover input tax.

Sveda sought to recover VAT incurred on its capital costs, including the recreational trail which members of the public can access freely. This was on the basis that it intended to make taxable supplies of catering and sales of souvenirs. The local tax authority refused this VAT repayment claim because the costs incurred were not used for an activity subject to VAT.

The AG concluded that EU VAT law allows a taxable person to recover input VAT incurred “on the acquisition or production of capital goods, which are directly intended for free use by the public, but can be used as a way to encourage visitors to come in a place where the taxable person, in exercising its economic activity, is considering providing goods and/or services”.

This opinion, although not a final decision, is important for a number of reasons and may explain the representations of the UK Government at the hearing.

HMRC, when dealing with an entitlement to recover input VAT, often use the “cost component” argument. That is to say that there should be a nexus between a VAT cost incurred and an intended taxable supply. In addition, the taxpayer should take account of costs incurred when considering the price of its taxable supplies. HMRC are reluctant to allow input tax recoveries where taxpayers cannot demonstrate that costs incurred are considered when setting the price to customers of its supplies.

This is, of course, often a difficult test for charities who receive grants to support taxable activities to satisfy. In the case in point, the UK Government’s likely position (if this were a UK charity) would be to allow input VAT recoveries in respect of café and shop (costs incurred have a direct link to taxable supplies) but allow no input VAT recovery in respect of the trail because it is not used to generate taxable supplies. The AG disagrees with this approach, and if this opinion is followed by a judgement the following points should be considered by all organisations across the sector, but may be particularly relevant to charities offering free access to sites and buildings. This may include, but is not limited to, wildlife and conservation charities, arts organisations and cultural bodies.

Where a charity allows free use of an asset (free admission to premises for example) HMRC tend to view this as a non-business activity and seek to restrict input VAT recoveries. This is particularly so if an element of grant funding supports certain activities, and the charity is unable to demonstrate it is making taxable supplies. If the AG’s opinion is followed the possible implications are:

  • If a charity allows an asset to be freely used, but with an intention to generate taxable supplies, free access has a business purpose and it is a business asset of the charity.
  • If a business asset has a dual purpose, one which is to make taxable supplies, an input VAT restriction is only likely to apply if the asset is used to make VAT exempt business supplies.
  • If the cost of the asset is supported by grant funding this is not critical in determining input VAT entitlement.
  • If the cost of the asset produces identifiable taxable supplies a clear link is established for input VAT purpose.

Any charity which has restricted input VAT recoveries on capital projects or other activities, may wish to consider protecting its position in view of the fact that retrospective adjustments to VAT returns rendered are capped at four years.

 

Upper Tribunal

Whether HMRC barred from entering into a binding agreement to settle a claim

Southern Cross Employment Agency Limited (SC) was an agency which supplied nurses to dentists. In 2010 HMRC made a payment of £1.4 million to SC in settlement of a claim for output tax accounted for on supplies which it had treated as standard rated, and which HMRC agreed were VAT exempt. HMRC then changed its mind and sought to recover the amount repaid on the basis SC’s supplies were standard rated. SC’s contention was that the repayment of VAT had been made under a binding contractual agreement. HMRC argued that Section 80 of the VAT Act 1994 barred it from entering into any such agreement and doing so would be ultra vires and void. The First Tier Tribunal ruled in favour of SC.

The Upper Tribunal (UT) considered three issues. In relation to issue 1 the UT found that Section 80 did not bar HMRC from entering into a binding agreement. Section 85 allows HMRC to enter into a binding agreement in the context of an appeal. The UT noted that there was no reason why such an ability would not exist in the absence of an appeal. The second issue was also found in favour of SC, the fact that it was later established that supplies of dental nurses were standard rated and not exempt did not make the agreement void. The third issue was whether a contractual agreement was entered into, again the UT found in SC’s favour. Therefore, HMRC were bound by a contract and could not recover the amount of repaid VAT.

 

First Tier Tribunal

Penalty for input tax error – whether error ‘deliberate and concealed’ or ‘careless’

Servbet Limited appealed against a penalty of £14,773 issued by HMRC for an error in its 10/11 VAT return in which input tax was claimed in relation to an invoice for £118,188 (including VAT of £19,698) for work that was never undertaken. It was accepted that the disclosure of the error was prompted by HMRC and a penalty was payable. HMRC contended that this should be calculated on the basis that the error was deliberate and concealed (penalty applicable between 50% and 100% of the potential lost revenue) Servbet claimed the error was made carelessly and this should be reflected in the size of the penalty (penalty applicable between 15% and 30% of the potential lost revenue). The reduction for the quality of the disclosure is also disputed.

During a VAT inspection by HMRC in 2012 HMRC were presented with the purchase invoice in question. The HMRC officers present at the visit claimed Servbet confirmed the purchase invoice had been paid. This statement was not recorded in the officers’ visit notes and was only mentioned in the officers’ subsequent undated visit report. Servbet insisted that it would not have said the invoice had been paid as the company representative who met with HMRC was not responsible for the day-to-day management of Servbet. The Tribunal preferred Servbet’s recollection of events.

The Tribunal found that as there was no direct evidence that Servbet played any part in the creation of the purchase invoice (which was in fact a quotation) the error was not “concealed”. The Tribunal found that Servbet should have made further enquiries but the inclusion of the invoice in the VAT return was careless rather than deliberate. The Tribunal also found that further reduction should be given for the quality of the disclosure.

Whilst not a charity specific case, this highlights the readiness of HMRC to impose penalties on taxpayers. We recommend that if charities receive VAT inspections from HMRC that any queries arising be confirmed in writing to avoid confusion. If an inspection from HMRC produces no issues we would suggest charities maintain a note of points discussed and records inspected.

 

  1. VAT refund scheme for certain charities

In our March 2015 newsletter we briefly covered announcements made in the Budget. One of which was that from 1 April 2015 VAT incurred on goods and services used for non-business activities will be available to certain ‘qualifying charities’. Qualifying charities include: palliative care charities, air ambulance charities, search and rescue charities, and medical courier charities. HMRC has published VAT Notice 1001 which provides further detail with regards to the VAT refund scheme. This is good news and if you would like to discuss the scheme please contact us.

 

  1. Penalties for errors

A new penalty system for errors was introduced on 1 April 2009. A penalty may be charged if an inaccurate VAT return (or other document) is submitted and an incorrect VAT declaration arises. The standard amount of a penalty for:

  • a careless action (or omission) is 30% of the potential lost revenue;
  • a deliberate but not concealed action (or omission) is 70% of the potential lost revenue; and
  • a deliberate and concealed action (or omission) is 100% of the potential lost revenue.

The ‘potential lost revenue’ is the amount of the error; for example, amount of VAT underpaid or over claimed.

CVC has assisted clients in disclosing errors to HMRC and mitigating penalties. These errors are often due to a variety of reasons including accounting software issues, staff illness, or complex VAT liability issues. HMRC’s position is that if a person knows about an inaccuracy when a VAT return, disclosure or claim is submitted this is classified as a deliberate error. In addition to being exposed to a larger penalty HMRC are also able to revisit VAT periods retrospectively over twenty years where HMRC can demonstrate that an error was ‘deliberate’ (generally HMRC are only able to revisit VAT accounting periods going back four years). Therefore, we would always recommend that where an inaccurate VAT return or claim is likely to be submitted HMRC is notified prior to the submission.

CVC are able to assist charities and not for profit organisations that have been issued penalties for errors contained within their VAT returns or that need to disclose errors to HMRC. Please note that HMRC must reduce a penalty to reflect the quality of a disclosure. For example, where a person who would otherwise be liable to a 30% penalty has made an ‘unprompted disclosure’ of the error to HMRC, HMRC may mitigate the penalty to 0%. In determining how much to mitigate the penalty by HMRC will look at the timing, nature and extent of the disclosure. We would always recommend that errors are fully disclosed to HMRC as soon as discovered. If a charity faces difficulty in determining the correct output or input VAT figures to be included on a VAT return we would recommend contacting HMRC. HMRC may give permission for estimated VAT returns in advance of submission of the VAT return.

 

  1. Barter Transactions

It is important that charities and not for profit bodies are able to identify barter transactions as these may present VAT obligations of which the organisation is unclear. In the case of a barter transaction there are two supplies. Each party’s supply constitutes the consideration it is providing in return for the supply from the other party.

For example, a charity uses a printer to print and distribute its magazine; the printer does not charge for this service and instead retains advertising revenue generated from the charity’s magazine. In this scenario there is a supply of printing services to the charity and a supply by the charity of advertising. The value of the charity’s supply would usually be the revenue generated from the advertising in the magazine. The charity would be required to account for VAT on this amount even though it did not receive the revenue (if the charity is not VAT registered it would need to consider the value of its supply when calculating whether it has exceeded the VAT registration threshold [Zero-rated supplies of advertising to other charities is still taxable for VAT registration purposes]). The value of the printer’s supply is the amount it would normally charge for its services. The printer may issue a VAT only invoice to the charity for the VAT it is required to account for. If the charity is not VAT registered the VAT will be an absolute cost. If the charity is VAT registered and makes VAT exempt and/or non-business supplies it may be unable to recover all or some of the VAT incurred.

 

  1. Prompt Payment Discounts

Until the 1 April 2015, most businesses offering a Prompt Payment Discount (PPD) as part of their standard terms only accounted for VAT on the discounted price, even if the full price was subsequently paid. Some charities were able to benefit from the discounts by reducing irrecoverable VAT costs. Some charities may themselves offer PPD.

Doubts over whether PPD rules complied with EU law meant changes were made to the UK legislation in the Finance Act 2014. These changes came into force for the majority of businesses on the 1st April 2015. Businesses must now account for VAT on the amount received rather than the discounted price.

This may leave businesses in the uncomfortable position of not knowing how much VAT to charge when initially raising a sales invoice, or how to go about accounting for this unknown. HMRC suggest two possible solutions:

  1. Issue an invoice for the full amount of VAT on the original, undiscounted net sales value (albeit showing the rate of the PPD offered on the invoice) and if the PPD is taken up, issue a credit note for the difference.
  2. Issue an invoice, for the full amount of VAT on the original, undiscounted net sales value, ensuring it contains the terms of the PPD (which must contain, but not necessarily be limited to, the time by which the discounted price must be made) and a statement that the customer can only recover as input tax VAT paid to the supplier. If the customer complies with the terms of the PPD and takes the discount on payment then no credit note need be issued, but the VAT should be accounted for on the lower amount received.  The supplier needs to be able to show the receipt of the smaller amount if HMRC challenge the reduced VAT declared.

Of these two options, we would imagine that most businesses would choose the second. However, a large part of the decision may be taken out of the businesses’ hands and come down to how well the software it employs copes with the change.

There are two risks with using option 2.  The supplier might not make the correct disclosure on the invoice to allow option 2 to be operated. Secondly, the customer might take the discount even when they have not complied with the terms of the PPD.  This would leave the supplier:

  • needing to issue credit notes (if it decides to allow a discount outside the PPD terms);
  • with a liability to account for more VAT than it has actually been paid (HMRC will expect this); or
  • chasing customers for the additional sums due (because PPD conditions have not been met).

The complexity described above relates to the supplier.  It will be duplicated for customers, who will also be required to ensure that they claim the right amount of VAT and make the correct adjustments depending on whether they meet the PPD terms and the policy that any particular supplier has adopted.

Charities offering PPDs may wish to agree a tailored approach with HMRC that reduces some of the problems these new rules present.

 

Constable VAT Consultancy LLP (CVC) is a specialist independent VAT practice with a nationwide client base and offices in London and East Anglia. We work together with many charities and not-for-profit bodies ranging from national charities to regionally based organisations.

We understand that charities wish to achieve their objectives whilst satisfying the legal requirements placed upon them. Charities may be liable to account for VAT on supplies made and VAT will be payable on certain expenditure. As irrecoverable VAT represents an absolute cost to most charities, regardless of their VAT registration status, there is a need to review the position regularly and carefully. We offer advice with planning initiatives, technical compliance issues, complex transactions, help with innovative ideas on VAT saving opportunities, and liaising with HMRC.

If you would like to discuss how VAT impacts on your organisation please contact Stewart Henry,  Laura Beckett or Sophie Cox on 020 7830 9669, 01206 321029 or via email on stewart.henry@ukvatadvice.com, laura.beckett@ukvatadvice.com and  sophie.cox@ukvatadvice.com.  Alternatively, please visit our website at www.ukvatadvice.com where you can view some of the services we offer in more detail and subscribe to our free general and regular VAT alerts and updates. Visit our website for current news updates. You can also follow CVC on Twitter.

This newsletter is intended as a general guide to current VAT issues and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains or for any errors or omissions. CVC cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this newsletter. Specialist VAT advice should always be sought in relation to your particular circumstance.