VAT: The distinction between grant funding and contracts for services

The recent case of Woking Museum and Arts and Crafts Centre v HM Revenue & Customs (2014) is a timely reminder of the need to consider the VAT implications when public sector bodies provide grants or outsource the provision of services to charities

When a public body is considering outsourcing any services or functions to a charity, there are two basic models available:

1. Grant funding

This is where the public body operates a grant programme or scheme to provide funds for a specific purpose. For VAT purposes, this is treated as non-business and not consideration for any supply by the charity so no VAT is chargeable.

2. Procurement of services

This involves a public body entering into a contract with a charity for the provision of specific services. VAT will be chargeable if the charity is registered for VAT and the services in question are of a kind which is taxable.

On 16 September 2003, Woking Borough Council (the Council) and Woking Museum and Arts and Crafts Centre (the Centre) entered into a contract whereby:

  • The Centre agreed to provide “arts museum and cultural services” (essentially a museum) and a Woking visitor information service to the Council.
  • In return, the Council paid an annual sum of £224,000 (to rise in line with inflation), together with various one off payments.

HM Revenue & Customs opined in April 2004 that these arrangements were outside the scope of VAT, and accordingly the Centre should not charge VAT on the £224,000 paid by the Council. Although the Tax Tribunal decision does not comment on the rationale for this ruling, it was presumably to prevent recovery of attributable input tax by the Centre. Notwithstanding the ruling, the Centre did charge VAT and (following a site visit in September 2011) HMRC wrote to the Centre to reiterate its view that no VAT was chargeable. The Centre appealed against that decision letter to the Tax Tribunal.

The Tax Tribunal rejected HMRC’s argument that the payments were, in effect, grant funding provided by the Council to the Centre (from which the Council received no specific material benefit). The Tax Tribunal held that the services supplied by the Centre were subject to VAT, primarily for the following reasons:

  • There was clearly an enforceable contract for services between the Council and the Centre rather than grant funding. If the services had not been provided, the Council would have been entitled to sue for breach of contract. The services provided by the Centre were explicitly described as being “in consideration of the annual payment”.
  • The Centre was not obliged to do anything in particular with the sums provided by the Council (cf. typical grant funding).
  • The services provided a significant and direct benefit to the Council (giving effect to the policy it was pursuing of displaying its collection of artefacts and art works).
  • The arrangements were not non-commercial in nature. The Tax Tribunal explicitly noted that a transaction is not non-economic simply because it involves a charity pursuing its charitable objects. There was reasonable evidence that the relationship between the Council and the Centre was on an arm’s length basis (even though the Centre was the only party interested in providing the services and so had a “special relationship” with the Council).

Cases of this kind (such as Bath Festivals Trust in 2008 and Aberdeen Sports Village in 2012) are a useful reminder of the VAT implications of outsourcing by public bodies (eg, local government or the NHS) to charities. Anecdotal evidence within the sector suggests that HMRC are taking a renewed interest in the VAT distinctions between grant funding (outside the scope of VAT) and taxable supplies of services, motivated by either the collection of additional output tax or seeking to deny input tax deductions (depending on the circumstances).

In addition, organisations providing grant funding are coming under increasing pressure to justify the grants, and may seek to impose conditions on the use of those funds which potentially stray beyond merely ensuring that the use of the donation is properly accounted for, and into territory in which VAT may apply.

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