Tax and VAT

VAT at 40: a win for the exchequer but a loss for the charity sector

Last month, the start of a new tax year, was an unexpectedly busy one for charities, with procedural changes afoot to Gift Aid claims and PAYE, and the introduction of the new Gift Aid Small Donations Scheme.

Amidst this noise, a tax milestone worthy of comment almost passed us unnoticed; VAT celebrated its 40 birthday! Given the sector’s long-standing adversarial relationship with it, it's a timely reminder of the VAT anomalies charities face even after 40 years.

VAT has always been a hugely controversial area for charities - and is possibly the finest example of where the failure to account for the unique nature of charities in policy making has resulted in them being massively disadvantaged over a long period of time.

The new Value Added Tax was first introduced when Britain joined the European Economic Community back in 1973. It was levied on most goods and services at a flat rate of 10%, rising to 15% in 1979, a level at which it remained until the late 1990s. Its original intention was straightforward: a simple, easy to collect tax at a low, flat rate whereby the cost of a service or product is paid by the final consumer on all but the most essential goods and services. Charities, who operate outside this underlying principle as they rarely charge for their goods and services, were not part of Government thinking at the time. This was no doubt partly due to the smaller size of the sector and the fact that it did not have the collective voice it has on many issues today. But how the VAT landscape has evolved!

With standard rating now at 20%, VAT is the government's third largest source of revenue after income tax and national insurance. And ‘simple’ is one of the last words that spring to mind when one considers its application and administration. Exemptions, reduced and zero ratings are aplenty (and with good reason when it comes to charities), resulting in a hugely complex framework. It hasn’t been without controversy either, as we’ve seen with hot pasties (what constitutes hot?), Jaffa Cakes (is it cake or a biscuit?), and Pringles (when is a crisp a crisp?). There is a whole multi-million pound industry devoted to probing and challenging these types of questions. As rates have crept up over the years, it has also come in for criticism for its regressive nature - the fact that it hits the poorest hardest. Nonetheless PwC estimate that it has brought in £1.6tn for the Exchequer over the course of its existence.

So what’s the charity sector’s relationship with VAT? While a number of valuable exemptions and zero ratings are available, the sector has been particularly concerned with the scale of ‘irrecoverable’ VAT it faces. The Charity Tax Group, who have long campaigned for a fairer tax system, estimate that this irrecoverable VAT costs charities in the region of £400m-500m per year. Unlike the private sector, charities cannot pass VAT costs on to the end consumer, nor reclaim it like the public sector. No one would argue with paying the VAT on trading activities, but charities pay large amounts of VAT buying products or services essential to delivering their objects. One of the early proposals put forward by the sector to improve this was for a grant scheme from public expenditure to compensate charities for the VAT incurred on exempt and non-business activities. But successive governments over the years have opposed this on the grounds of cost to the Exchequer, particularly as the sector grows, and principle, arguing that a tax relief on donations (Gift Aid) was a more effective method of supporting charities as it also incentivised people to give. Interestingly, Chancellor Geoffrey Howe stated during his 1983 Budget speech that he opposed such a scheme on the basis that it would be indiscriminate in its effects, “benefiting not only those charities which do valuable work in the community but also - and sometimes disproportionately so - many other bodies with very limited or controversial aims which do not command public support,” something we’d hope not to hear from a Government minister today, and an antiquated argument given the sophistication of the charity legal framework and public benefit requirements that come with it.

The outcome of a Government-led Charity Tax Review in 1999, which sowed the seeds for the expansion of Gift Aid, also noted that: ‘A fundamental principle of VAT is that organisations and individuals can only recover VAT to the extent to which they make taxable supplies. If individuals or organisations are not making taxable supplies, they cannot recover VAT on the things that they buy. This includes charities providing services for no charge and those making exempt supplies. To give charities this tax back would be contrary to this fundamental principle.’ Nearly 15 years on from that review, it remains unlikely that any government will revisit the concept of a comprehensive VAT rebate scheme in the near future, but there are some small steps forward.

In November 2011 the Lords passed an amendment to the Health and Social Care Bill placing a legal requirement on government that health providers are not discriminated against on the basis of their legal and ownership structure. This resulted in a recent NHS Monitor report ‘A fair playing field for the benefit of NHS patients’ recommending that charities (such as hospices) should be entitled to the same VAT rebate as public sector providers when they bid for NHS contracts. While not groundbreaking when we look a the detail, it is at least being acknowledged by Government with some commitment to explore in more detail.

So what else is in store for VAT as it enters its forties? We’ve already seen Government efforts to clampdown on ‘borderline anomalies’ as they take a tighter grip on the reigns of the public purse. And the EU, who we know is not keen on the reduced rates offered by the UK, is reviewing existing legislation in this area. It’s almost certain VAT will be celebrating quite a few birthdays to come but unfortunately it’s looking like the existence of current reduced rates should not be taken as a given. As a sector we should be working to ensure policy makers recognise the challenges VAT poses to charities, and the value of these reduced rates.

This post was last reviewed on 6 August 2018 at 14:46
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