New guidance on business and non-business activities for VAT purposes

18 November 2022| CATEGORIES: New VAT policy, VAT| TAGS: HMRC, New policy

HMRC has published new guidance on determining whether or not an activity is a business activity for VAT purposes.  Revenue and Customs Brief (10) 2022 sets out HMRC’s new approach following the Court of Appeal decisions in the VAT cases Longridge on the Thames [2016] BVC33 and Wakefield College [2018] BVC 22.

The changes will be particularly relevant for:

• charity organisations
• non-profit making organisations
• businesses providing nursery and crèche facilities
• businesses that receive grants or subsidies
• organisations or businesses carrying out non-business activities.

Why is this important?

Determining whether an activity is a business activity for VAT purposes is important. This is because no output VAT is due on income received from non-business activities. In addition, the income does not count towards the VAT registration threshold.

However, input VAT cannot be claimed on costs that directly relate to a non‑business activity and an apportionment is necessary if costs are relevant to both business and non-business activities.

The old approach

The principles laid down in the cases of Lord Fisher [1981] STC 238 and Morrison’s Academy Boarding Houses Association [1978] have historically been used to decide whether an activity is business or economic activity for VAT purposes. The 6 criteria that emerged from these cases, known as the ‘business test’, include:

• is the activity a serious undertaking earnestly pursued?
• is the activity an occupation or function that is actively pursued with reasonable or recognisable continuity?
• is the activity have a certain measure of substance in terms of the quarterly or annual value of taxable supplies made?
• is the activity conducted in a regular manner and on sound and recognised business principles?
• is the activity predominately concerned with the making of taxable supplies for a consideration?
• are the taxable supplies that are being made of a kind which, subject to differences of detail, are commonly made by those who seek to profit from them?

HMRC previously accepted that where a charity supplies nursery and crèche facilities for a consideration that is fixed at a level designed to only cover its costs, this is not a business activity for business purposes.

More recent court cases however have provided further clarification, in particular that there should be no reliance on an organisation’s overall objective or profit motive.

Recent court decisions

The Court of Appeal in Longridge emphasised that the correct test for determining whether an activity is a business activity is whether there is a direct link between the services or goods supplied and the payment received by the supplier. The ‘predominant concern’ is irrelevant. This means focusing on whether there is a direct link between the services the recipient receives and the payment made, rather than on the wider context of the organisation’s charitable objectives or motive.

In Wakefield College the Court of Appeal considered whether the activities were business activities for VAT purposes based on a 2-stage test.

The 2-stage tests are:

• Stage 1: The activity results in a supply of goods or services for consideration

  This requires the existence of a legal relationship between the supplier and the recipient. The first step is to consider whether the supply is made for a consideration. An activity that does not involve the making of supplies for consideration cannot be business activity for VAT purposes.

  The Court of Appeal in Wakefield emphasised that a ‘supply for consideration’ is a necessary condition but not a sufficient condition for an ‘economic activity’.

• Stage 2: The supply is made for the purpose of obtaining income therefrom (remuneration)

  Where there is a direct or sufficient ‘link’ between the supplies made and the payments given, the activity is regarded as economic. The Court in Wakefield College made a distinction between consideration and remuneration. Simply because a payment is received for a service provided does not itself mean that the activity is economic. For an activity to be regarded as economic it must be carried out for the purpose of obtaining income (remuneration) even if the charge is below cost.

HMRC’s new policy

In light of these recent cases, HMRC will no longer apply the business test based on the 6 indicators from Lord Fisher and Morrison’s Academy in determining whether an activity is business.

The 2-stage test set out above, is the approach that should now be taken when determining whether an activity constitutes a business activity.

HMRC have stated that businesses can no longer rely on the old ‘business test’ to decide whether an activity is business or not, but it can be used as a set of tools designed to help identify those factors which should be considered.

Please get in touch if you think your business may be impacted by this policy change.