VAT recovery – the tussle with HMRC continues

A subject that never seems to go away is the issue of how much VAT can be claimed on charity purchases.  Quite apart from the difficulty of determining whether, say, an activity is business or not, or exempt rather than zero rated, which can drastically affect the level of recovery, there is the issue of the approach to apportionment of the related costs.

This itself breaks down into two issues.  The one often most carefully considered is the way to measure the use of apportionable costs; by determining a formula for percentage recovery.  The second is the question of allocation.  Does any single cost relate solely to taxable activity, solely to non-taxable activity, or to a mixture of these?  Allocation has a profound impact on the amount that can be claimed.  And it is not as simple as the question seems to suggest.  A charity may think a cost solely relates to taxable uses, but HMRC may think it is apportionable.  Or a charity may apportion the cost whereas HMRC sees it as wholly non-recoverable.

This latter dilemma is explored in the case of Adullam Homes TC06921.

This charity is a housing association that provides a range of services to local authorities.  In this case there were two services in question: the provision of residential accommodation, and the provision of additional services to the occupants.  Both were sold to the local authority.  HMRC and the charity agreed that the accommodation supply was exempt, and the additional services were taxable.  This was assumed to be the case even though the local authority contracted for both services in the one document.  That was an important factor in the decision.

The issue was whether the costs of maintaining the accommodation were apportionable or wholly non-recoverable.  So, it was a question of the correct allocation of the costs and not of the formula for any apportionment.  HMRC said these costs solely related to the exempt rent, whereas the charity said they were used for the provision of both this and the additional service (though only where the additional services were provided, since in some cases there was a supply only of accommodation).

The tribunal sided with the charity and agreed that the costs were apportionable.  It seems likely, I think, that HMRC will appeal.

The logic of this decision was that the services were provided under a single contract, and that the arrangement with the local authority was thus for a supply of both services.  Since the additional services could only be provided if the accommodation was also provided, and not as something detached from the accommodation, the costs of providing the accommodation had a ‘direct and immediate link’ with the additional services.  The trite point, that one does not search for the most important use of the costs, but for any and all directly relevant uses, was relied on by the tribunal to reach this conclusion. That, in itself, must be right.  But was there even a link of that kind, or was it that accommodation was a pre-condition of making the additional supplies of taxable services?  If it was merely a pre-condition then the link was only a ‘but for’ kind of link, which is to say that ‘but for doing X, I could not have done Y’.  ‘But for’ links do not count as direct links.

The tribunal posed that question and said it was more than a mere ‘but for’ link.  The contract required the whole package, so no part of that package could be relegated to a merely consequential or co-incidental relationship with another part.  Any cost incurred in delivering the contract was a cost of the whole contract.

Is this convincing?

One slight discord in this is that the usual analysis of the supply side of a single contract is to give it a single VAT treatment.  On that basis the single treatment would have been taxable, with no exempt element.  But, the parties had agreed the premise that there were exempt accommodation supplies, so that issue was not on the table.  The implication of the decision is perhaps that it ought to have been.  The conclusion, otherwise, is that there is an asymmetry between the inputs analysis and the outputs analysis.

However, local authorities can reclaim VAT unless they make an onward exempt supply of the services.  If that was not the case here, then the local authority could reclaim all VAT charged on a fully taxed service, which would remove the above issue entirely.  So, looked at holistically, the decision appears to get us to the correct outcome, or even one that is not sufficiently favourable for the charity, since it involves the cost being apportioned.

But, standing back from the holistic view, and looking more forensically at it, there is something curious in the situation.  If all that had been supplied was exempt accommodation, the exact same costs would have been incurred and none of the input tax would have been reclaimed.  It is only because something else has been added to the mix that some of the input tax can be reclaimed.  Also, the ‘goose and gander’ issue could arise in another case.  The ability to claim some of the VAT on the basis that a cost applies to all of a contract, could imply partial non-recovery on a cost which otherwise appears only to relate to the taxable supply, but which arose in the context of a single contract.  It is a double-edged sword.  I am uneasy about that.

Since it is probable that it will be appealed, we will see whether it survives as a principle for general application.

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