Business vs. non-business VAT: A breakdown

/ Posted By - Bradleys Accountants / Categories - Advice for Small Businesses

What counts as a business activity? And, for that matter, what makes a business a bona fide VAT-eligible business? There has been a lot of uncertainty around this, and the directives from HMRC are not always the clearest.

One of the most critical principles behind VAT is the tax incurrent should be concerning goods or services supplied for VATable business activities. Then only can a taxable personal recover input VAT. Fret not – we have combed through the facts and opinions and sifted out the essentials to help you make the right business decisions. Read on for more:

A bit of history behind business and non-business activity

As far back as 1978, there were rules in place to determine whether an activity counted as a business activity. Lord Fisher and Morrison’s Academy Boarding Houses Association set a six-rule business test that ran as follows:

The point to note here is that it does not matter so much as to whether all six criteria are met, as to use them to evaluate the bigger picture and see whether a business activity is taking place or not. More recently, the focus has shifted to the extent of the direct link between the services rendered/goods supplied and the payment received.

In other words, it does not consider the purpose behind the activity (including charitable purposes) – only whether there exists a link between what the customer gets in exchange for payment. Particular note can be made of the 2018 Wakefield College case, where the Court of Appeal employed a two-stage process to determine the business/non-business status of an activity:

It is also important to remember here that a business includes any ‘trade, profession or vocation,’ as well as any benefits or facilities offered by a ‘club, association or organisation’ in return for a fee. A business could also refer to any one-off project or deal, like constructing a house for sale.

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    Why does knowing the difference between business and non-business activity matter?

    Determining whether or not an activity is business or non-business is required to know whether a company is eligible to register for VAT, or even whether they must compulsorily do so by law. And in the context of VAT, a non-business income cannot be subjected to output tax, while input tax cannot be claimed for a non-business expense.

    It can only be claimed on expenses if they relate to a business activity and taxable sales. This issue is important to note when only zero-rated sales are made, ie.e, where repayment VAT returns will be submitted each period.

    What is the problem?

    According to the latest HMRC guidelines, charities, churches or other non-profit organisations that run creches or nurseries for fees that only cover costs (without bringing in profits) do not have to count the construction of new buildings as a business activity.

    So if the charity/church were to construct a new building while “otherwise than in the course of furtherance of business”, it could issue a zero-rating certificate for the same. Based on the old-six stage test, charities like the Yarburgh Children’s Trust have done so.

    However, with the new two-stage test, the second part raises the question about whether the activity was carried out to get remuneration, even if the charge was below cost. Essentially, this removes the earlier non-business assumption about charities running creches or nurseries.

    Moreover, there is no mention of when strictly this approach kicks in legally. And while there is indication that this will apply retrospectively, charities often operate under what is known as the clawback rule.

    This means that a property was built and zero-rated but later shifted to business use, a VAT clawback/adjustment will apply. So it could be that clawback will apply to all charities that built creches under the old rules.

    Another point of confusion relates to whether or not the old six-stage test can even be used to determine the business VS non-business question. The guidelines seem to indicate that the six-stage test cannot be used exclusively but can be used to answer the two-stage test. However, more clarity is needed on this.

    Over to you

    As a takeaway, we can point out that it would not be hard to make the business/non-business classification in most cases. Most business owners provide services in return for profit, meaning all related activities are business activities.

    Where doubt exists, however – as in the case of non-profit organisations – it is worthwhile to consult the HMRC internal policy manuals.

    Suppose you receive both VATable and non-VATable income and are unsure about whether you can recover any VAT. In that case, it is worth taking the time to get the right advice and information about the legal status of your activities. You can speak to an experienced accountant from Bradleys Accountants to get the clarity you need.

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