HMRC has contacted selected charities reminding them to review VAT recovery on non-business activities. Incorrect classification could result in over-recovery of input tax and penalties. Charities should act now, assess their position, and seek professional guidance where needed.

HMRC has issued an important reminder to charities, emphasising the need to review VAT recovery practices, especially when dealing with non-business activities. Charities must fully understand the distinction between business and non-business activities, as this classification directly impacts entitlement to VAT recovery.

However, the line between what constitutes a business or non-business activity isn't always clear leading to potential errors in VAT treatment. Over the years, the question of what constitutes a business activity has been the subject of litigation, particularly concerning the treatment of grant funding. HMRC’s current position of what it believes constitutes a business activity was outlined in a 2022 Business Brief that sets out a two-stage test:

• Stage 1: Does the activity result in a supply of goods or services for consideration?

• Stage 2: Is the supply made for the purpose of obtaining ongoing income or remuneration?

If both conditions are met, the activity is classed as a business activity, and hence there is entitlement to VAT recovery if taxable supplies are made. Despite this guidance, many charities still struggle to classify their activities correctly, which can lead to costly VAT errors and compliance risks.

What does this mean for you?

For charities receiving this HMRC email, it is crucial to assess whether your VAT recovery practices are correct. If non-business activities have been treated incorrectly or there are irregularities, you could face penalties which can vary in severity, especially as any subsequent disclosures would likely be viewed as ‘prompted’ for penalty purposes.

Given HMRC's current focus on this area, now is the time to review your VAT accounting practices to ensure correct VAT restrictions are applied, thus reducing the risk of non-compliance and penalties. Disclosure before any contact from HMRC, reduces the level of potential penalty.

How we can help

We have a team of specialist VAT consultants who advise the charity sector and regularly liaise with HMRC on charity matters. We are therefore well placed to support and guide charities with their VAT reporting requirements and in the event of HMRC enquiry, can assist with any disclosure or mitigation of potential penalties.

In cases of more detailed enquiry/action from HMRC we also have a team of Tax Investigations specialists who can provide support where needed, including the negotiation of time to pay arrangements.

If you have concerns about your VAT accounting processes or would like to discuss this matter, please contact our VAT team.