Hard on the heels of the increase in VAT rate back to 17.5% comes more bad news and further challenges for charities.  This update touches on three of them.

(1) The end of  ‘Lennartz’

HMRC recently published its long-awaited policy on the application of Lennartz following an important judgement of the European Court of Justice last year.

As many charities and FE colleges are aware, the Lennartz mechanism allows upfront VAT recovery on buildings that are to be put to both taxable business and non-business use.  An output tax charge is then made by the charity or college over the economic life of the building, which HMRC regards as being 10 years.  The availability of this procedure assists the cash flow position considerably, and indeed, some projects may not be possible without it.

HMRC’s new policy

From 22 January 2010, Lennartz accounting is only available for business assets put to private use.  In exceptional circumstances HMRC will allow Lennartz accounting where the asset is put to use ‘wholly outside the purposes of the taxpayer’s business/enterprise’.  This would not include everyday ‘non-business’ use of buildings by charities and colleges as that use in not outside the purposes of their enterprise, which is to provide education or charitable services.

We considered that it would have been inequitable for HMRC to retrospectively apply any change in policy following this ruling.  HMRC has now confirmed that this is the case and a taxpayer may opt to continue to use Lennartz accounting arrangements for existing assets where this has already begun. Following announcements in the recent Budget, charities that have adopted Lennartz treatment must continue to make output tax payments for non-business use over the economic life of the building. 

HMRC states that taxpayers may apply to HMRC if they have not yet agreed a Lennartz deduction but have entered into binding commitments for projects on the understanding that Lennartz accounting would be available.

A major blow for property projects

For many charities and colleges that are considering a new construction project or property acquisition this news will come as a major blow.  Going forward, any VAT incurred on the property must be recovered according to the intended use of the building.  Only that proportion related to taxable business use will be recoverable.  As a consequence, the impact of this policy change on charities and colleges will depend greatly on the level of their taxable income.  Those entities with little taxable turnover will suffer severe adverse cash flow consequences on any construction project/property acquisition as a result of this policy change.

This is coupled with the imminent changes to the VAT relief for construction services relating to non-business use of a building. Charitable organisations will need to reappraise all property developments as a matter of urgency.

(2) Introduction of the VAT package

Many charities making or receiving international supplies of services are affected by the ‘VAT package’, which is a set of European measures that took effect across the entire European Union from 1 January 2010.

New obligation to register?

For charities, one major concern is the potential obligation to register for VAT in the UK, or to pay VAT on services received from overseas.

Under the new rules, if the charity carries on any business activity (it is irrelevant whether the service from overseas will actually be used for business or for non-business purposes), the overseas supplier will not charge local VAT.  Instead, the charity will be required to account for UK VAT under the reverse charge procedure.  If the charity is not VAT-registered, the value of these reverse charge services will count towards taxable turnover for the purposes of the VAT registration threshold.  Additionally, the VAT charge may be a cost to the charity.

A good example of this is the services of overseas agents in locating foreign students for UK schools/colleges.  As the school is deemed to be a taxable person, it may be required to register for UK VAT as a result of receiving these reverse charge services from overseas agents.

Additional costs?

Another concern is the additional cost of purchasing certain services from outside the EU as these are now subject to VAT in the UK, compared with their current treatment as outside the scope of EU VAT.

These new rules apply to almost all supplies of services and there are very few exceptions.

There are a number of further issues arising from the VAT package that may affect certain charities.  This is particularly the case if the charity makes any supplies of services to EU customers.

Charities that are not sure how the VAT package  affects them, should seek advice immediately.

(3) Challenge to UK grouping provisions

The European Commission (EC) has recently requested that eight Member States amend their legislation in respect of VAT grouping. The UK is among these Member States.  The EC has begun infringement proceedings on the basis that the UK allows non-taxable persons to be a member of a VAT group and this is believed to be non-compliant with European law.

Impact on VAT groups

This is potentially very bad news for charities that obtain increased VAT efficiencies by including entities in a VAT group that undertake purely non-business activity e.g. donation collection.  Going forward it is likely that they will be excluded from VAT grouping and will be directed to leave current VAT groups.  It should be noted that exempt activity still counts as business activity under EC law so any entities undertaking solely exempt activity should still be permitted to VAT group.

Organisations will need to review their group structures in light of this announcement and consider how to minimise VAT losses.  Although the UK government was given two months to amend the legislation in question, the issue will take much longer than this to be resolved.  This is because the UK has opted to defend its current provisions. Despite this, affected organisations should begin their review as soon as possible.