20 THE TAX JOURNAL Monday, 29 June 2009

BACK TO BASICS – VAT & PUBLIC BODIES

Is the public body acting in the course or furtherance of a business?As discussed above, 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 legislation provides that ‘States,

regional and local government authorities

and other bodies governed by public law

shall not be regarded as taxable persons

[that is, they 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’ (EU

VAT Directive 2006/112/EC, Article

13(1)).

This does not provide a general carve

out for public bodies from the VAT regime

but does provide that to the extent they

are carrying out statutory functions they

do not have to charge VAT. In the UK

rather than referring to the bodies not

being taxable persons in respect of the

relevant activities, we tend to refer to

these activities as being ‘non-business’

activities.

Which bodies qualify as public bodies?HMRC takes the view that to qualify as

a public body, the body in question must

be acting under a special legal regime

applicable to bodies governed by public law.

HMRC reviewed its guidance on the

concept of a ‘public body’ for the purposes

of Article 13(1) in 2008, in response to

an increasing number of ‘quasi-public’

bodies arguing that they fell within the

definition. The updated guidance, reacting

to cases brought by two educational bodies

in particular, states that a body will only be

a public body for these purposes if ‘it is a

public sector body which forms a part of

the UK’s public administration, such as a

government department, a local authority

or a non-departmental public body. Article

13(1) is not intended to enable other

bodies to claim special treatment merely

because they have delegated powers, are

regulated in some way by the State, are

funded by public money or are subject

to certain specific rules in the pursuit of

their activities.’

What activities are covered by these provisions?The general rule in Article 13(1) only

applies to the statutory functions

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.

In addition there are several activities

specifically excluded from the ambit of

Article 13(1). First, Article 13(1) carves out

certain activities from its application unless

they are carried out on such a scale as to

be negligible, these include the supply of

utilities such as gas and electricity, supplies

of telecommunications and supplies of

transport. In addition the Treasury provides

a list pursuant to VATA 1994, s 41(2) of

supplies (similar to those provided by

private enterprise) which when made by

government departments will be treated

as made in the course or furtherance of

a business. The list was published in the

London Gazette on 7 June 2002.

VAT a n d Pu b lic

Bo d ie sContinuing our series of basic, informative articles, Liz Morgan, Partner, and Jon Robinson, Solicitor, Pinsent Masons LLP explain how VAT applies to certain public bodies

In this ‘back to basics’ article we

consider the VAT issues relevant

to public bodies, in particular local

authorities and government departments.

B efore we do that, however, it is worth

reminding ourselves of some fundamental

rules governing the charging and recovery

of VAT.

The starting point is that VAT is

charged on a taxable supply of goods or

services in the UK, where that supply is

made by a taxable person in the course or

furtherance of a business.

In general these same principles

apply to a public body as they do to a

commercial enterprise. However, some

of the concepts 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 parties but it raises some

interesting questions when one is

considering public bodies.

The other side of the VAT coin 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 attributable to taxable

supplies made by him in the course or

furtherance of his 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.

However, 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.

The starting point is that VAT is charged on a taxable supply of goods or services in the U K , where that supply is made by a taxable person in the course or furtherance of a business

Monday, 29 June 2009 THE TAX JOURNAL 21

BACK TO BASICS – VAT & PUBLIC BODIES

Finally, supplies will not be treated as

being non-business where treating them as

such would lead to significant distortions

of competition.

The issue of public bodies and

distortions of competition has recently

been considered, both in the UK courts and

the European Court of Justice, in H M R C

v I s le of W ig h t C ou nc il and oth er s [2008]

STC 2964, ECJ and [2009] All ER (D)

125 , which concerned a local-authority-

operated car park. The ECJ was of the view

that ‘would lead to’ includes both actual

and potential competition with a private

operator, provided that the possibility of a

private operator entering the market is real.

The ECJ further ruled that ‘significant’

distortions of competition means ‘more

than negligible’. Car-parking provides a

useful example of how these rules will

be applied. The provision of on-street

parking which is a statutory function

carried out only by local authorities will

be a non-business activity, whereas the

provision of off-street parking where there

is competition from private operators will

be a business activity.

It is worth noting that just because

particular services are subject to

contracting out by the local authority,

so a private business is involved in the

provision of the services, it does not

make the supply by the local authority

one which is the subject of competition

from private businesses and hence subject

to VAT. It is important to distinguish

between the supply by the private operator

to the local authority and the supply by

the local authority to the public. There is

particular guidance in a number of areas

on the VAT treatment of contracted out

services including in the catering sector

and the provision of leisure facilities.

W here supplies are made by a public

body in the course or furtherance of a

business then, subject to very limited

exceptions, the normal rules will apply to

determine whether the supply is standard-

rated, z ero-rated or exempt.

R ecovery of input taxW ithout special rules recovery of input

tax could be a real problem for public

bodies because input tax attributable to

their non-business activities would not be

recoverable. However, the normal rules for

recovery of input tax are varied for certain

public bodies.

W hen looking at recovery of input tax

public bodies can be divided into three

categories:

bodies falling within VATA 1994, s 33,

which covers local authorities and certain

others, including passenger transport

authorities, police authorities, development

corporations and the B B C

government departments and other

Crown bodies, including health service

bodies, which are governed by s 41

public bodies which fall within neither

of the above sections. The recovery of input

tax for these bodies is governed by general

principles.

S ection 3 3 bodiesSection 33(1) provides for a special

recovery regime which means that most

bodies falling in its ambit will be in a

position to recover all input tax. The

scheme only applies to 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 to this refund scheme, local

authorities also have a particular recovery

position under s 33(2) in respect of input tax

attributable to VAT-exempt activities, which

differs from the normal partial exemption

rules. L ocal 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 and less than 5 0% of the

total input tax incurred, 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.

If the result of the calculation is that

input tax attributable to VAT-exempt

activities falls within the limits set out

above, all of it is recoverable. If the limits

are exceeded, none of it is recoverable. This

‘5 % 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. As a result it is currently

subject to review. W hile the review is going

on HMRC has announced a moratorium

on the application of the 5 % threshold.

However, the moratorium is only being

granted on a year-by-year basis, which is

providing significant uncertainty for local

authorities in planning for future years.

L iz M organ Jon R obinson

W ithout special rules recovery of input tax could be a real problem for public bodies because input tax attributable to their non-business activities would not be recoverable. H owever, the normal rules for recovery of input tax are varied for certain public bodies

22 THE TAX JOURNAL Monday, 29 June 2009

BACK TO BASICS – VAT & PUBLIC BODIES

G overnm ent departm entsA separate input tax refund mechanism

exists under s 41, which al lows

government departments and health

authority bodies to 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 bodies governed by s 33

and is principally intended to encourage

outsourcing of functions by these bodies

by removing the VAT charge which would

otherwise arise.

The bodies which qualify for the

scheme and the eligible goods and

services are listed in a Direction published

by HM Treasury. The most recent list was

published in the London Gazette on 10

January 2003.

In other respects the input tax recovery

position of government departments is

the same as for other businesses.

G rantsO ne 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. A supply is anything done for a

consideration.

W here a public body provides a grant

to another body it is always important to

consider whether it is genuinely a grant

(which will not be treated as consideration

for any supply and 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

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 the

distinction is not always an easy one.

R egistration for V A TThe normal registration rules apply

to public bodies other than local

authorities. 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 pursuant to VATA 1994,

s 42.

C onclusionIn 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, which means

that public bodies need to consider VAT

in whatever they are undertaking.

L iz Morgan can be contacted on e-mail:

L iz .Morgan@ pinsentmasons.com and

tel: 020 7418 8218. Jon Robinson

can be contacted on Jon.Robinson@

pinsentmasons.com and tel: 0113 368

65 70.

B A C K T O B A S IC S

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