Outsourcing by public bodies

The distinction between grants and contracts can become an important issue when looking at public bodies outsourcing services to charities. There are two different funding methods available to the public body to finance the service: by grant-funding the charity or by procurement under a contract for service (i.e. by entering into an agreement with the charity, under which the public body pays the charity fees for providing a specified service):

  • Grant-funding is not a business transaction for VAT purposes.
  • Procurement is a business transaction for VAT purposes.

It is also worth noting that if the services are procured as a contract for specific deliverables, as well as being business for VAT purposes the activity is likely to be trading for direct tax purposes.

Certain public bodies such as central Government departments, the NHS, local authorities, the national museums etc. benefit from special VAT status which allows them to recover the VAT incurred in relation to their statutory non-business activities. Where the public body procures a service that is subject to VAT (i.e. is not an exempt supply) the public body will pay VAT on the purchase price of the service. It may then be able to recover the VAT under its statutory right of recovery, but this depends on the particular VAT regime that applies to the public body in question. For example, local authorities can recover the VAT that they incur on goods and services purchased in respect of their statutory non-business activities. However, NHS bodies and a significant number of central government departments have a different VAT regime that allows them to recover VAT incurred on certain services that are used for their statutory non-business activities (‘Contracted Out Services’). Not all public sector bodies fall within either of these special VAT regimes, in which case they may not be able to recover the VAT that is charged to them. In effect they would have the same VAT issues as charities and other not-for-profit organisations.

Where a charity charges VAT to public bodies it will be able to recover the VAT for which it is liable on its costs attributable to the service. Where the service is an exempt supply, however, the public body will not be charged VAT on the purchase cost of the service, but neither will the charity be able to recover any of the VAT for which it is liable on its attributable costs.

Note that if the funding method applying to the charity is grant funding it may be possible to come to an agreement with the funder for the irrecoverable VAT to be added to the contract price.

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