Without a doubt, the biggest talking point following the emergency budget in June, is the increase in the VAT rate. To the lay person this may not seem like a problem in the charity sector but those involved with charities know better. There have been various reports in the national press estimating that, as a result of the VAT rate rise, the increase in cost to UK charities will be in the region of £140million a year.

It is not uncommon for a VAT registered entity to be unable to recover all the VAT it incurs. In certain sectors organisations are hit by “partial exemption” which enables them to recover a percentage of the VAT they have incurred. Charities, however, effectively take a double hit as they have to restrict VAT recovery at 2 stages.

Firstly, a charity must review its business and non-business income and in many cases restrict the recovery of VAT relating to its non-business income. Secondly, the business income must then be split between taxable and exempt activity and once again VAT is restricted under the partial exemption rules.

It is all very well to focus on the doom and gloom but the harsh reality is that the VAT rate will increase so we need to focus on what we can do to help charities manage this.

This may be the time to analyse your VAT position and perhaps re-visit any agreements you have in place with the tax authorities. For example:

• You are not VAT registered as your business activities are below the VAT threshold but perhaps a voluntary registration would now be beneficial; or
• You are VAT registered but perhaps no longer need to be;
• You have a business/non-business split agreed with HMRC which is potentially out of date;
• The operations within the charity have changed considerably since you agreed a partial exemption method;
• You are using a standard partial exemption method when perhaps a special method would be more appropriate.

Arguably there is no better time to review all or some of the above areas.

Many small charities may find the increase in their cost base hard to absorb. Therefore, it is important to review the VAT position over the next couple of months to ascertain whether there is scope to manage or mitigate this cost.

If you would like any help with regards to VAT issues please contact Katie McGavigan at kmcgavigan@menzies.co.uk.

This article is taken from the Autumn 2010 issue of Menzies' Charities Insight publication.