VAT on grant income and related expenditure
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HMRC guidance on VAT and grants has been updated and significantly changed during 2018. This fact sheets looks at the issues potentially facing any VAT registered business that has grant income. For all of these points you should look at the situation now and in future; and also over the past four years.
Has there been any misclassification of grants?
You should carefully consider whether any particular receipt of money is a grant (outside the scope of VAT) or a payment for a supply (subject to VAT). A payment for supply can be paid by the beneficiary of the supply or paid by a third party. If a funder is paying for particular services (or goods) to be supplied to themselves, or to be supplied to other named parties, this will be a supply subject to VAT.
HMRC give new guidance (2018) on the factors that support a payment being a grant, and factors that support a payment being for supply. We would be happy to discuss these factors in context of grants you have or will receive.
Are any grants payment towards supplies to third parties and effectively subject to VAT even though they are grants?
Some projects may be partly paid by the beneficiary (you have probably treated these as a VATable supply) and partly paid for by grant funding (you may have treated as outside the scope of VAT). HMRC have published an example showing that such a project can potentially have a VAT invoice raised for the whole value of the supply, including the grant funded element. HMRC show that if a project is worth £100,000 and has been paid for by £20,000 from the beneficiary, £70,000 from a grant for the project and £10,000 from general grants and donations, then a VAT invoice should be raised for £90,000 (being the direct payment and specific grant). The invoice should show a supply with a value net £75,000 + VAT £15,000 = gross £90,000 less grant subsidy £70,000 = amount due (and paid) from beneficiary £20,000.
Have either of the above points led to under declaration of VAT output tax (VAT on sales)?
If any items have been treated as grants (no VAT) but in fact could be supplies then you need to consider your response. This will depend on how strongly the evidence weighs towards being a supply. It may be that some income treated as grants will need to be reclassified and output tax (VAT on sales – either 20% on top of the grant or 1/6 of the grant) will need to be declared to HMRC and additional VAT paid to them. It is far better to self declare than have HMRC find an error, not least because the penalties would be significantly more in the latter case (penalties could be as much as the VAT involved).
Is there a restriction on reclaiming VAT input tax (VAT on costs)?
There is a general principle of VAT that VAT cannot be reclaimed on non-business activities. Indeed VAT only works as a tool to collect tax if there is a VAT cost at the end of the supply chain.
HMRC guidance relating to VAT on grant funded expenditure has changed. A VAT specialist has reported: “HMRC stance has changed in the last year (2018). They now say if income is for business activities it must be a supply and therefore subject to VAT. On the other hand if the income is purely to support loss making (or zero income) projects and is a true grant then the input tax relating to that cannot be reclaimed as it is not business related. Previously HMRC had said grants supporting an otherwise loss making business did not change the nature of the VAT input tax claim. Also note that they are going back on cases on this – up to four years.”
If all income of an entity is in fact for supplies (business) then there is no problem. All input tax (VAT on costs) that has been reclaimed. This would still be the case if the entity has some grant funding of its overheads or general business, as long as the grant funding is not paying directly for projects.
However if you receive grant funding directly for a project and VAT is not due on that grant funding (e.g. the project is purely grant funded) then this is not a business activity. In this case the input tax on costs relating to that project cannot be reclaimed. You then have some business projects and some non-business projects which meas that VAT on overheads should be apportioned on a “just and reasonable” basis.
The interaction of VAT and grant funding can be complex and costly. Please contact us to discuss any aspect of this further.
Has there been any misclassification of grants?
You should carefully consider whether any particular receipt of money is a grant (outside the scope of VAT) or a payment for a supply (subject to VAT). A payment for supply can be paid by the beneficiary of the supply or paid by a third party. If a funder is paying for particular services (or goods) to be supplied to themselves, or to be supplied to other named parties, this will be a supply subject to VAT.
HMRC give new guidance (2018) on the factors that support a payment being a grant, and factors that support a payment being for supply. We would be happy to discuss these factors in context of grants you have or will receive.
Are any grants payment towards supplies to third parties and effectively subject to VAT even though they are grants?
Some projects may be partly paid by the beneficiary (you have probably treated these as a VATable supply) and partly paid for by grant funding (you may have treated as outside the scope of VAT). HMRC have published an example showing that such a project can potentially have a VAT invoice raised for the whole value of the supply, including the grant funded element. HMRC show that if a project is worth £100,000 and has been paid for by £20,000 from the beneficiary, £70,000 from a grant for the project and £10,000 from general grants and donations, then a VAT invoice should be raised for £90,000 (being the direct payment and specific grant). The invoice should show a supply with a value net £75,000 + VAT £15,000 = gross £90,000 less grant subsidy £70,000 = amount due (and paid) from beneficiary £20,000.
Have either of the above points led to under declaration of VAT output tax (VAT on sales)?
If any items have been treated as grants (no VAT) but in fact could be supplies then you need to consider your response. This will depend on how strongly the evidence weighs towards being a supply. It may be that some income treated as grants will need to be reclassified and output tax (VAT on sales – either 20% on top of the grant or 1/6 of the grant) will need to be declared to HMRC and additional VAT paid to them. It is far better to self declare than have HMRC find an error, not least because the penalties would be significantly more in the latter case (penalties could be as much as the VAT involved).
Is there a restriction on reclaiming VAT input tax (VAT on costs)?
There is a general principle of VAT that VAT cannot be reclaimed on non-business activities. Indeed VAT only works as a tool to collect tax if there is a VAT cost at the end of the supply chain.
HMRC guidance relating to VAT on grant funded expenditure has changed. A VAT specialist has reported: “HMRC stance has changed in the last year (2018). They now say if income is for business activities it must be a supply and therefore subject to VAT. On the other hand if the income is purely to support loss making (or zero income) projects and is a true grant then the input tax relating to that cannot be reclaimed as it is not business related. Previously HMRC had said grants supporting an otherwise loss making business did not change the nature of the VAT input tax claim. Also note that they are going back on cases on this – up to four years.”
If all income of an entity is in fact for supplies (business) then there is no problem. All input tax (VAT on costs) that has been reclaimed. This would still be the case if the entity has some grant funding of its overheads or general business, as long as the grant funding is not paying directly for projects.
However if you receive grant funding directly for a project and VAT is not due on that grant funding (e.g. the project is purely grant funded) then this is not a business activity. In this case the input tax on costs relating to that project cannot be reclaimed. You then have some business projects and some non-business projects which meas that VAT on overheads should be apportioned on a “just and reasonable” basis.
The interaction of VAT and grant funding can be complex and costly. Please contact us to discuss any aspect of this further.