Welfare services outsourced to a charity by an LA are VAT exempt

The appeal

In the First Tier Tribunal (FTT), the YMCA argued there were two supplies:

1. A supply to the LA of managing and administering the housing-related services and;
2. A supply to the individuals who were benefiting from the supply. 

The welfare exemption in item 9 Group 7 Schedule 9 VATA 1994 applies to services, which are directly connected with “the provision of care, treatment or instruction designed to promote the physical or mental welfare of elderly, sick or distressed persons.” YMCA took the view that because its services were supplied and paid for by the LA, the exemption did not apply, as the LA was not a ‘distressed person’ and in any event, the services provided were not of care, treatment or instruction.

However, HMRC argued that there was one supply of services by the YMCA, which was made to the individuals, and YMCA received third party payment from the LA, therefore the welfare exemption applies and the YMCA could not reclaim VAT on associated costs.

The First Tier Tribunal (FTT) decision

The FTT rejected the YMCA’s argument that the services were supplied to the LA because there was nothing in the legislation that required the recipient of the services to be the person who paid for them. Instead, there was a supply of services by the YMCA to individuals, which were paid for by the LA. Therefore, the question was whether the services amounted to ‘instruction’ designed to promote the physical or mental welfare of ‘distressed’ persons.

The FTT referred to the Oxford English Dictionary for the definition of the terms ‘distress’ and ‘instruction’. The term ‘distress’ was defined as “Afflicted with pain or trouble, sorely troubled; in sore straits, applied specifically to a person living in impoverished circumstances”, which the FTT found was an accurate description of the people receiving the housing services who stayed in the YMCA hostels.  

There were several definitions of the word ‘instruction’, but the one that was found most applicable to the issue at hand was “That which is taught; knowledge or authoritative guidance imparted by one person to another’’.

The FTT also decided that given that the intention of the services supplied by the YMCA was to ensure that individuals could live independently and not be homeless, the services it supplied were designed to promote that persons physical or mental welfare. The FTT therefore dismissed the appeal.

The Upper Tribunal (UT) decision

The UT hearing was a virtual rerun of the issues already considered by the FTT. The YMCA sought to change its argument in the UT, by suggesting that the service was of advice and information, but that argument failed. The UT agreed with the FTT that there was nothing in the VAT Act or the Principal VAT Directive that required the person benefiting from a service to be the person paying for it.

The YMCA sought to argue that by treating the services as exempt, the cost to the LA was increased, as the LA would have to fund the irrecoverable VAT costs of the YMCA, whereas had the LA undertaken the services itself, VAT would not represent a cost and argued this was a ‘perverse’ result. The UT concluded, however, that the legislation was clear and unequivocal. The UT could find nothing wrong with the approach adopted by the FTT in reaching its conclusion that the individuals receiving the services were in ‘distress’ and could be regarded as receiving ‘instruction’. 

The outcome

The detrimental effect of LAs outsourcing their welfare obligations to charities (who are not in a position to reclaim VAT), when VAT would have been deductible had the LA supplied the services, has been the subject of debate for a number of years. However, this decision makes it clear that where a LA outsources its obligation to provide a particular service, it does not automatically follow that the LA is the recipient of the supply, even though it has paid for it.

Organisations that have contracts with LA’s should review the VAT treatment to ensure it reflects this decision.

For more information on the above or for VAT advice tailored to your organisation, please get in touch with VAT Partner, Socrates Socratous, or fill out the form below.