What has been the effect of COVID-19 on VAT Recovery?

Charities recover VAT on costs incurred on their activities undertaken within a tax year. The COVID-19 pandemic has directly limited some of the activities that can be undertaken by charities. Consequently, the VAT recovery permitted for the year end 2020/21 could look very different to a charity’s usual VAT recovery position, with the potential for substantial amounts of VAT having to be paid back to HMRC. This article looks at the issue and some possible solutions.

Background

Charities are often involved in ‘non-business’ and VAT exempt activities and therefore cannot recover all of the VAT incurred on costs. In these instances, apportionment calculations are undertaken to recover a fair amount of the VAT on overheads depending on the activities undertaken. 2020 may have led to activities being very different from those undertaken in a ‘normal’ year and so this may in turn lead to a substantially different recovery position. Unfortunately, the effect will often be negative (less VAT recovery). Typically it has been the taxable activities which afford VAT recovery, such as the running of charity shops, /cafes, and the letting of conference space which will have reduced whilst other supplies such as the exempt services have remained consistent or in many cases there has even been an increase in the provision of free ‘non business’ activities as charity’s have responded to this crisis

What can be done?

Where the activities of a charity have changed during the year it might be that the change in recovery reflects the level of different activities completed by the charity in this tax year and in these cases there will be no further action required. However, where there have been no activities undertaken as a result of lockdown, an adverse impact on VAT recovery could be unfair.

HMRC officers are aware of the potential impact on charities but there cannot be a ‘one size fits all’ approach because of the diversity of different charities’ activities. Therefore, currently HMRC is suggesting taxpayers write informing of their circumstances and making proposal to address any inequality in a charity’s VAT recovery.

We have listed some factors to take into consideration before any approach is made to HMRC

• When is your ‘annual adjustment’? Unless a non-standard year end has been agreed the VAT year will end on 31 march, 30 April, 31 May. It is important that HMRC are approached before the annual adjustment is declared which is usually the VAT period after the end of the VAT year.
• Would the last year’s recovery rate be more reflective of consumption of input VAT? Where there have been no activities or aborted activities the VAT legislation does allow for looking at intention and so a previous years VAT recovery would potentially lead to a fairer recovery rate on this basis.
• Do I need to formally change my current method? This may be required where there have been a significant change in activities. For example, if a charity took on a large exempt contract to care for COVID-19 sufferers or their families.
• Do we have any building works in the ‘Capital Goods Scheme’ (where VAT recovery is determined over the first 10 years of use) which are affected by the reduced VAT recovery?
• Where the difference in recovery is substantial it may be possible to use the ‘overrides’ in the VAT legislation to allow a different methodology to be used.

What should be done now?

1. Undertake the ‘annual’ partial exemption calculation early – this will give an indication as to whether or not the results for the year will be distorted and whether HMRC need to be contracted.
2. If the results of the above do indicate a substantial difference we would recommend looking into whether the result is fair based on the activities undertaken.
3. If the answer to ‘2’ is ‘no’ then solutions to remedy the position should be looked into and HMRC contacted to notify of any proposed changes.

Conclusion

• Changes to usual trading patterns caused by COVID-19 could affect VAT recovery.
• Often the result will be that less VAT can be recovered but in some cases this may not produce a fair result and so alternatives should be examined.
• For any charity operating partial exemption and/or business non-business apportionments it is important to get an indication of the potential effect on VAT recovery.
• HMRC should be contacted with proposals for rectifying any disparities. Do not just accept any big changes to recovery, either up or down, as being fair.

If you would like to discuss this issue further, please get in touch with your usual Crowe VAT contact or email [email protected].