It is a common misconception by charities that the receipt of grant income by a VAT registered organisation means it will have to restrict its VAT recovery.
VAT law allows VAT registered organisations to recover VAT, to the extent that they make taxable supplies. Charities are unusual in that their activities can be a mix of business and non business activities e.g. where it engages in the provision of services for no charge. Where a VAT registered charity undertakes free of charge activities we would expect some restriction in VAT recovery (a fundamental principle of VAT recovery is that the VAT must be incurred in the course or furtherance of a business and be used to make taxable supplies). This is commonly done by including grant income in a pro rata calculation, where a percentage is applied to determine how much overhead VAT the organisation can recover.
The Chiene + Tait VAT Team has come across several instances recently where grant funded organisations have restricted their VAT recovery, even where only taxable activities are undertaken. This tends to happen where grant funding subsidises a charity’s taxable activity, allowing prices to be kept low.
HMRCs internal guidance confirms that “the receipt of outside the scope income [i.e. grants] does not automatically mean that an activity is not business or lead to apportionment of VAT. The receipt of money to act as a subsidy for a loss making commercial activity need not result in input tax restriction”.
We would recommend that charities and organisations receiving grant income review whether they have under-recovered VAT in light of the issues above. If this is the case it may be possible to make a claim to recover this VAT from HMRC.