VAT is charged on a taxable supply of goods or services made in the United Kingdom, where that supply is made by a taxable person in the course or furtherance of a business. In general the same principles apply to a public body as to a commercial enterprise. However, some of the concepts of VAT can be more difficult to apply to public bodies. In particular, the concept of a supply made 'in the course or furtherance of a business' is straightforward in the case of most commercial organisations, but it raises some interesting questions in relation to public bodies.
Another important point is the question of recovery of input tax. In order to recover input tax, the recipient of the supply must be a taxable person and the supplies giving rise to the input tax must be taxable supplies made by that person in the course or furtherance of its business. Input tax attributable to exempt supplies or non-business activities cannot therefore be recovered. This could present problems for public bodies as they will be making significant non-business supplies.
In order to address this and prevent VAT being an absolute cost, special rules apply to public bodies to allow them to recover VAT which would not be recoverable under these general principles.
This guide considers these and other VAT issues relevant to public bodies, in particular local authorities and government departments.
Is the public body acting in the course of furtherance of a business?
The key issue in terms of charging VAT, and to a lesser extent in the recovery of input tax, is deciding to what extent – if at all – a public body carries out activities 'in the course or furtherance of a business'.
EU law provides that 'states, regional and local government authorities and other bodies governed by public law' do not have to charge VAT in respect of 'the activities or transactions in which they engage as public authorities, even where they collect dues, fees, contributions or payments in connection with those activities or transactions'.
This does not provide a general exclusion from the VAT regime for public bodies, but it does provide that to the extent that they are carrying out statutory functions they do not have to charge VAT. In the UK, we tend to refer to these activities as being 'non-business activities'.
Which bodies qualify as public bodies?
HMRC takes the view that to be a public body for these purposes, the body in question must be acting under a special legal regime applicable to bodies governed by public law. This covers public sector bodies which form part of the UK's public administration such as government departments, local authorities or non-departmental public bodies. HMRC guidance makes it clear that other bodies cannot claim special treatment merely because they have delegated powers, are regulated in some way by the state or are funded by public money.
What activities are covered by these provisions?
The rule that VAT does not have to be charged only applies to the statutory functions or non-business activities undertaken by a public body. There is a significant amount of guidance and case law as to which activities will be treated as non-business and which will not.
A number of activities are specifically excluded from the provisions unless they are carried out on such a scale as to be negligible. In addition, a formal direction issued by HM Treasury sets out a list of supplies which will be treated as made in the course or furtherance of a business when made by government departments. Finally, supplies will not be treated as being non-business where treating them as such would lead to significant distortion of competition.
The issue of public bodies and distortions of competition has recently been considered in the European Court of Justice (ECJ), in a case involving Isle of Wight Council's operation of a car park.
On the issue of whether the car park's operation would lead to a significant distortion of competition, the ECJ was of the view that the phrase 'would lead to' includes both actual and potential competition with a private operator, provided the possibility of a private operator entering into the market is real. The ECJ further ruled that a 'significant' distortion of competition means one that is 'more than negligible'. The case is still going through the UK courts for the principles established in the ECJ decision to be applied to the facts.
Where supplies are made by a public body in the course or furtherance of a business, subject to very limited exceptions, the normal rules will apply to determine whether the supply is standard-rated, zero-rated or exempt.
Recovery of input tax
Without special rules, recovery of input tax could be a real problem for public bodies because input tax related to their non-business activities would not be recoverable. However, the normal rules for recovery of input tax are varied for certain public bodies.
When looking at recovery of input tax, public bodies can be divided into three categories:
- bodies specifically covered by section 33 of the Value Added Tax Act, which covers local authorities and certain others including passenger transport authorities, police authorities, development corporations and the BBC;
- government departments and other Crown bodies including health service bodies, which are covered by section 41 of the Value Added Tax Act;
- public bodies which fall within neither of these categories. The recovery of input tax for these bodies is governed by general principles.
Section 33 bodies
There is a special VAT recovery regime for bodies covered by section 33 of the Value Added Tax Act. This allows them to recover all input tax which is attributable to non-business activities. It applies whether or not the authority is registered for VAT or makes taxable supplies.
In addition these bodies, which include local authorities, can recover input tax attributable to VAT-exempt activities, but only if this input tax is an 'insignificant proportion' of the total input tax incurred by the authority in any year. HMRC takes the view that an 'insignificant proportion' means that the input tax attributable to exempt supplies must be less than 5% of the total input tax incurred on all purchases, or not more than £625 per month if greater.
In calculating the amount of input tax relating to exempt activities, a local authority must include both input tax directly attributable to exempt activities and an appropriate proportion of its overhead VAT (this is the VAT which is a general overhead of the local authority and cannot be attributed to specific supplies). If the result of this calculation is that input tax attributable to VAT exempt activities falls within the limits set out above, all of it is recoverable. If these limits are exceeded, none of it is recoverable. This test is therefore extremely important for local authorities.
The 5% test can give rise to problems, especially where a local authority is carrying out significant redevelopment projects which may involve substantial exempt supplies. The test has been under review for a number of years.
Government departments
Government departments and health authority bodies can recover certain input tax attributable to supplies received by them for non-business activities. This is a less generous mechanism than that which applies to the bodies listed in section 33 of the Value Added Tax Act, and is principally intended to encourage these bodies to outsource certain functions which VAT would otherwise apply to. The bodies which qualify for the scheme and the eligible goods and services are listed in a direction published by HM Treasury.
In other respects, the input tax recovery position of government departments is the same as for other businesses.
Grants
One common issue which can arise in the context of public bodies is the VAT treatment of grants. The definition of supply for VAT purposes is very wide, as a supply is anything which is done in exchange for a consideration. Where a public body provides a grant to another body it is therefore important to consider whether it is genuinely a grant - which will not be treated as consideration for any supply and is therefore not subject to VAT - or whether it should be treated as consideration for a supply.
HMRC guidance makes it clear that just because conditions are attached to the grant to make sure it is being used for its intended purpose, this will not necessarily mean it will be treated as consideration for a supply. However, where it is a condition of the grant that the public body or any third party receives anything in return for the grant, it should properly be treated as consideration for a supply. Any grant funding arrangements need to be carefully reviewed, because this distinction is not always obvious.
Registration for VAT
The normal registration rules apply to most public bodies, however special rules apply to local authorities. If a local authority makes taxable supplies in the course or furtherance of a business, it must register for and charge VAT whatever the value of the supplies.
Conclusion
The application of the VAT rules to public bodies is by no means straightforward, which is demonstrated by the amount of case law in this area. Difficult issues arise both in terms of when they have to charge VAT, and also on their ability to recover VAT on services provided to them. This means that public bodies need to consider the VAT implications of whatever they are undertaking.
This guide is based on an article by Pinsent Masons which appeared in The Tax Journal on 29 June 2009.