Campaign: Irrecoverable VAT
Why VAT is a problem for charities
The basic model of VAT is a simple one: suppliers charge VAT on most of the goods and services they provide to a particular organisation, which then charges VAT on the goods and services which it, in turn, supplies to its customers. Eventually, the final consumer pays the VAT - which is, in effect, a tax on consumption over which the final consumer is judged to have some control. The VAT that is collected on the organisation's sales (output tax) can then be set off against the VAT which the organisation has had to pay on its purchases (input tax).
While this model is entirely appropriate to the operations of a commercial organisation (and, indeed, to the activities of commercial trading subsidiaries set up by charities), it is entirely inappropriate to the core activities of charities: the provision of services to beneficiaries who may not be in a position to pay for the services they receive.
Most of the services provided by charities are either exempt (ie they cannot charge VAT and so cannot recover the VAT that they pay on their purchases) or they are non-business supplies (because the charity does not charge for the service or heavily subsidises it) and are outside the scope of VAT. In either case, the charity ends up with a substantial irrecoverable VAT bill, which is estimated to be in the region of £500 million a year.
Charities are almost uniquely penalised by the VAT system. As Government officials have long acknowledged, they are exposed to the most complicated VAT regime facing any sector because they provide a mix of fully taxable business supplies, exempt business supplies and non-business supplies. The administration involved in calculating which bit of VAT relates to which type of service is complicated and onerous. Commercial organisations providing services do not have a problem recovering the VAT as they almost exclusively provide taxable services and local authorities receive an automatic refund of the VAT that they pay on providing services - many of which are identical to those provided by charities. This refund is permitted under section 33 of the 1994 VAT Act.