09 August 2022
A recent tribunal decision has raised a potential VAT recovery opportunity for charities and also thrown the spotlight onto inconsistencies in HMRC’s new approach to determining what is a business or a non-business activity carried out by a charity.
The Towards Zero Foundation is a global road safety charity based in the UK. It works with governments and consumer groups in various countries to introduce new car assessment programmes (NCAPs), with the aim of reducing traffic fatalities around the world. As part of its work, the charity carries out independent vehicle crash testing to a higher standard than the basic legal requirement of the country concerned, to inform customer choice and encourage manufacturers to further improve the safety of their vehicles. For example, star ratings for safety under its Euro NCAP scheme are often cited on consumer motoring websites and in publications such as ‘What Car’ magazine.
The initial crash testing of a vehicle is carried out without the manufacturers’ knowledge, so the cost of buying the vehicle as a ‘mystery shopper’ and carrying out the first test is funded by the charity. Should the result of the test on a particular vehicle be unsatisfactory, the charity then offers a retest of the vehicle, at the manufacturer’s expense, once improvements have been made.
A dispute arose with HMRC over whether the crash testing was a business or a non-business activity of the charity for VAT purposes. HMRC accepted that the second phase of testing, funded by the manufacturer, was a business activity, meaning that the charity was entitled to recover input VAT incurred on related UK costs. However, HMRC issued an assessment for £152,000 disallowing reclaims of VAT on the initial tests for which the charity did not make a charge, deciding that this was a non-business activity carried out to meet its philanthropic or charitable objectives.
However, the First-tier Tribunal has disagreed, deciding that the VAT was recoverable. It accepted the charity’s argument that its initial tests were a necessary investment to establish demand for the next phase of testing, paid for by the manufacturers. It was only as a consequence of unsatisfactory results from the charity funded testing that manufacturers proceeded to buy further testing services, which HMRC had agreed were business activities for VAT purposes. Had they been carried out in isolation, the tribunal noted that the fact that no charge was made for the initial crash tests would have meant that they were a non-business activity. But, in this case, both phases of testing amounted to a single business activity – the costs of the free testing are incurred as a necessary precursor to making taxable supplies of crash testing to vehicle manufacturers.
The tribunal judge also noted that the business status of this supply is not affected by the fact that the services were provided by a charity – standard restrictions in a charity’s constitution which prevent it from engaging in a trading activity do not mean that it cannot be engaged in a business activity for VAT purposes. Given HMRC’s recent update of its policy in this area, this tribunal case takes a timely look at this perennial issue for charities.
Firstly, the case highlights the potential to recover VAT incurred on initial costs where they eventually lead to taxable supplies by a charity. In light of this, some organisations might consider making retrospective refund claims.
It is also interesting to note HMRC’s argument in this litigation, that Towards Zero’s charitable objectives meant that its crash testing was not a business activity, clearly contradicts its position in its recent policy paper, which says that there should be no reliance on an organisation’s overall objective or profit motive to determine whether or not its activity is ‘business’ for VAT purposes.
The business/non-business test of course cuts both ways – some charities without a significant input VAT burden may aim to achieve non-business status so they do not have to charge VAT and/or register for VAT, or to show that they are eligible for certain VAT reliefs available only to charities.
Overall, the VAT business/non-business question reminds us that different charities have different priorities, and also that HMRC’s practical approach in individual cases is often inconsistent with its public statements. Charities should consider undertaking an independent review of the business/non-business status of their activities to establish the correct VAT treatment.