An organization must register for UK value-added tax (VAT) if it makes taxable supplies as a taxable person in the course or furtherance of any business activities. The requirement for a supply to be made in the course of a business is very wide and would cover many transactions that an organization might engage in.
However, if a VAT registered trader receives revenue for goods and services that have not been supplied as part of business activity, it cannot recover VAT paid on expenses relating to those supplies. The question of what constitutes a business activity is, therefore, an important factor in deciding what transactions are subject to VAT and how much VAT can be recovered by an organization.
Although business activities are not defined in the VAT law, they include a trade, profession or vocation and specifically include receiving club subscriptions or admission charges to premises. This can bring religious, philosophical and political organizations into the scope of business activities on some of their activities where they are receiving subscription income, even though the subscriptions themselves may be exempt from VAT. For VAT purposes, an organization can be performing business activities even if it is not making a profit and is not intending to do so.
Even an organization that receives a considerable amount of its income from donations can be regarded as having business activities for VAT purposes. For example, a Tribunal found that the Yoga for Health Foundation Ltd was engaged in some business activities even though around 43% of its income was received from donations. In other situations considered by Tribunals, religious bodies giving courses in aspects of religion were found to be carrying on a business for VAT purposes.
One of the intentions behind the VAT law is to create a level playing field among businesses to ensure that as far as possible no business is given an unfair advantage or disadvantage by the operation of VAT. For this reason, where a non-profit making body is performing an activity that is of the same nature as the activities of certain business organizations, it may be liable to VAT even though it is undertaking the activities without a view to profit.
Certain organizations may be involved in some business transactions but also have a non-business side to their activities. One major example is charities, whose main charitable activities are not subject to VAT but who may run business activities as part of their fund-raising efforts. Other examples are museums, which in the UK do not charge for entry to the main exhibition but may have a separate charge for special exhibitions. This type of arrangement may also exist in churches that do not have an entry fee but may charge for entry to a crypt or tower and may have a souvenir shop run as a business.
Where an organization has both business and non-business activities, it is necessary for the organization to set up systems and procedures that can distinguish between transactions relating to each part of the organization and ensure that the VAT on expenses relating to non-business activities is not recovered.
Where some of the business supplies are VAT exempt a second calculation would be required to disallow input tax arising from business activities but relating to the VAT exempt supplies. The organization would also need to compute any disallowance of VAT on general overhead expenses under the partial exemption provisions. The organization will need to carefully document strict procedures for distinguishing between the business-related and non-business related VAT in the accounting records and for identifying exempt transactions.
As an organization can have large amounts of irrecoverable VAT where part of the activities relate to non-business activities, the organization will attempt to establish that as much VAT as possible relates to business activities. However, any artificial scheme would be difficult to implement consistently and would be open to challenge from the tax authorities.
In certain cases, for example, where work is being done to restore and repair a building or monument that might later open to the public, the organization should consider if it is possible to register for VAT on the grounds that it intends to open to a fee-paying public at a later date. The decision of the European Court of Justice in the Rompelman case was that a business is entitled to apply for VAT registration where VAT is already being incurred on expenses that relate to future taxable supplies.
Registration for VAT at an early stage will ensure that the VAT paid on expenses can be reclaimed during the period before any sales are made. This ability to reclaim the VAT incurred could reduce the burden of expenses in the opening years of a business operation when the finances are most under pressure.
The VAT law in the area of business and non-business activities is not very precise and case law has not always clarified the situation. Any organization considering that it may be considered as engaging in business activities for VAT purposes should study the law carefully and if necessary ask for advice from external consultants.