VAT zero-rating of building work:

Stewardship Briefing Note 2014/2 VAT zero-rating of building work: the Capernwray and Longridge decisions December 2014 Stewardship, 1 Lamb s Passage, London EC1Y 8AB t: 020 8502 5600 e: enquiries@stewardship.org.uk w: stewardship.org.uk

CONTACT DETAILS Stewardship 1 Lamb s Passage, London EC1Y 8AB t: 020 8502 5600 e: enquiries@stewardship.org.uk w: stewardship.org.uk Stewardship is the operating name of Stewardship Services (UKET) Limited, a registered charity no. 234714, and a company limited by guarantee no. 90305, registered in England Copyright Stewardship 2014 COPYRIGHT This publication is the copyright of Stewardship. We want our resources to have the maximum impact, therefore you are welcome to reproduce or otherwise distribute this material in whole or part. We simply ask two things: (1) there must be no use for commercial gain, and (2) Stewardship is clearly acknowledged with the following wording Reproduced with permission from Stewardship. www.stewardship.org.uk. If extracts are to be used in another context, permission should be sought in advance by emailing enquiries@stewardship.org.uk or telephoning 020 8502 5600. Thank you. DISCLAIMER Whilst every care has been taken in the preparation of this material, Stewardship cannot be responsible for action taken or refrained from in reliance thereon. It is recommended that appropriate professional advice be sought in each relevant individual circumstance. 2 Stewardship briefing note: VAT zero rating of building work: the Capernwray and Longridge decisions

Introduction In two recent and highly relevant VAT cases, the Tribunal was asked to decide, amongst other things, whether or not the activities undertaken by the charities concerned were business activities for VAT purposes. The decisions are important because a number of VAT tax reliefs, most notably the eligibility for zero rating of the costs of construction of a new building, depend on the distinction between business (as VAT law sees the meaning of the word) and non-business. The VAT meaning is not necessarily obvious and significantly, charitable purpose has little or no bearing on it. These cases are of particular interest to Christian charities, and with professional advisors previous understanding of the law being challenged by HMRC, charities undertaking new building projects need to tread carefully when planning and budgeting for their particular project. The Capernwray decision In the Capernwray Missionary Fellowship case 1, reported in June 2014, it was decided that building works undertaken to construct a new Conference Hall could not be zero rated as the activities to be undertaken in the building would not constitute a relevant charitable purpose (or RCP ). In VAT law, RCP is specifically defined to exclude business activities. But was Capernwray undertaking business activities, so preventing VAT zero rating of the new build? Capernwray is a Bible School, providing term-time courses for Bible College Students and shorter courses for others, outside term-time. Activities include Christian worship. The First Tier Tribunal (FTT) ruled that anything done for a fee, charge or similar will usually be considered to be a business activity even if fees are set at a charitable level a fraction of an equivalent commercial rate. The CJEU 2 (Court of Justice of the European Union) Judgment in Commission v Finland 3 confirmed that economic activity', or business has a wide meaning and will normally cover anything done for consideration, irrespective of purpose and whether the aim is to make a profit. For an activity to fall outside business activity, the amounts charged would have to be substantially below market rate. By reference to EC v France 4 1/15 th of market rents was given as an example of a case falling the other side of the line. Although, in the Capernwray case, the activities were subsidised by donations, use of volunteers and so on, and the fees charged were well below those that a commercial organisation would charge, they were still set at a level calculated to cover costs. In this regard, the FTT determined that they were set on sound business principles. The activity was 1 [2014] UKFTT 626 (TC) 2 VAT is a European Tax governed by the European Union Principle VAT Directive. As such CJEU decisions take precedence over decisions of the domestic courts of Member States. 3 Case C-246/08 4 [1988] ECR 4797 3

also earnestly pursued, with continuity and substance. As such they fell the wrong side of the criteria for activities to be considered non-business set down in a case called Lord Fisher 5 and, were therefore business activities for VAT purposes. But the FTT did consider that there were cases where the activity in question was innately non-business, for example a community welfare activity outside the sphere of commerce completely, but held that the Caperwray case did not fall into this limited category of cases. It seems that these principles have been clarified further by a subsequent Upper Tribunal decision. At the time, fears arose from the approach taken by HMRC in the Capernwray case, and in particular, their assertion that Commission v Finland cast doubt on previous landmark decisions such as Lord Fisher and Morrison s Academy 6, as well as more recent decisions by the High Court in Yarburgh Childrens Trust 7 and St Paul s Community Project 8. However, Longridge on the Thames 9, reported in November 2014 and referred to further below, appears to have settled these anxieties at least for the time being, given that HMRC may yet appeal against the Longridge decision. Capernwray did however underline the clear principle that it does not matter what the purpose is in carrying out the activity. Charitable activity, even if run at a loss and perhaps subsidised from donations or grants, can still be a business activity for VAT purposes. This much is uncontroversial in law and what has to be shown, it seems, is that an activity is innately non-business (a somewhat elusive concept). As an aside, it was also held in Capernwray that the accommodation within the Conference Hall complex could not be considered to be a relevant residential purpose (RRP) which also would have qualified for VAT zero-rating, because the accommodation was used during holiday periods for those attending short courses and, in the circumstances, these people could not be students within the meaning of the word, as used in the RRP rules. The Longridge decision This case is very important because: (a) the Longridge Case was heard in the Upper Tribunal whereas Caperwray was heard in the First Tier Tribunal. As such, any conflicting Judgment in Longridge would create new legal precedent; (b) Longridge followed soon after Capernwray but neither Counsel for the Commissioners for HMRC, nor for the taxpayer, made any reference to Capernwray in submitting their arguments, nor did the Tribunal Judge make any reference to it in her decision; and (c) the Judge did, however, quote Yarburgh and St. Paul s with approval, which strongly indicates that these decisions remain good law. 5 [1981] STC 238 6 [1978] STC 1 7 [2002] STC 207 8 [2005] STC 95 9 [2014] UKUT 0504 (TCC) 4

Longridge on the Thames runs an activity centre predominantly for young people although a small proportion of its activities are designed for adults, or as part of corporate events. The amounts charged are set in advance by the trustees and are designed to make sure that the activities are affordable for the young people balanced with the need to cover operational costs after taking account of donations and the contribution of volunteers. A higher price is charged to adult groups and corporate events. 94.5% of users were young people, with only 1,438 adult users. The young people s activities were run at a loss before subsidies. Having made reference to Yarburgh, St. Paul s and Lord Fisher, the Tribunal Judge upheld the tests applied by the First Tier Tribunal in Longridge. The following broad principles emerged: Charging a price for services rendered brings about a rebuttable presumption of being in business but this is the beginning not the end of the enquiry ; Whether a person is engaged in [a business activity] is to be judged objectively, without reference to the purpose and results of that activity. Regard is to be taken to the nature of the activity and the context in which it is carried out; One must look at the totality of the observable terms and features of the activities carried out (as per the Yarburgh decision) and the wider context in which they are carried out; Although charitable purpose is not a criterion in deciding whether or not an activity is business, the charitable nature of the activity can be taken into account in deciding if the operation has an economic content, as part of assessing the observable terms and features. Regard must be taken of the six indicia of carrying on business as set out in Lord Fisher; Analysis of prices charged, their method of calculation and their relationship to costs does not necessarily lead to a conclusion that the activity is a business activity. Applying these tests, the fact that Longridge charged for its activities, and ran them and managed their financial affairs in a professional and businesslike manner did not prove fatal they were still to be regarded as not carrying on a business for VAT purposes. There is a nuanced interplay between the fact that the charitable purposes informed the financial decisions of the trustees, and whether or not the resultant activity is business activity. For example, it was relevant that all capital costs were funded separately and not from fees and charges to participants. The First Tier Tribunal concluded that the factors taken into account in the pricing of the activities were not indicative of a business noting in particular that the significant subsidy brought about by the time and services contributed by volunteers was essential to the way in which Longridge carries out its activities. In taking this position, the Tribunal quoted Yarburgh with approval. 5

Whilst some of the indicia in Lord Fisher were met, the activity was not consistent with sound business principles, most obviously its use and reliance upon volunteers and its reliance on donations to meet part of its operational costs and to meet all of its capital costs. The predominant concern is not to make taxable supplies to consumers for a consideration, but to carry out its activities in a manner which furthers its charitable objectives. The making of supplies for a consideration is incidental to its predominant concern of furthering its charitable objectives In considering the level of participation in the activities by the adults, and the income that this generated, the Tribunal seemed to treat the numbers of less relevance than consideration of the essence of Longridge s activities and the way in which it carries them out. In this regard, the substantially below market rate test, and the 1/15 th proportion quoted in Capernwray as a guide, seems to have been rejected. Conclusion Regardless of VAT registration status, a charity contemplating a large construction project will be keen to have the costs of the project zero-rated. After all, paying 20% VAT on a large sum is still a large sum! If the church (or charity) wishes to build new premises, or an annexe, the construction costs of which may potentially qualify for zero-rating for VAT purposes, it will need to satisfy itself that the intended use of the building will not only constitute a charitable purpose but that the activity or activities will not also be regarded as business activities, taking account of the rationale behind these decisions. Where part of the building is, and part is not used for a business activity, it is possible to apportion the building costs between the two and to zero rate the non-business part. Where the business use is de minimis, that is, it amounts to less than 5% of the total use of the building, it can be ignored, and zero-rating can apply to the whole building. The law surrounding the question of business v non-business is quite complex to apply and, therefore, appropriate professional advice is highly advisable especially given the sums usually involved in building projects. Further comment The meaning of business (or, to use the wording of the European Principle VAT Directive, economic activity ) has been interpreted both in the domestic and European Courts to include activities that the layman may not regard as business because the purpose of the activity concerned is not the generation of profit, and the activity may not be carried on in a commercial fashion. The court decisions have made it clear that interpretation is specific to the facts of each case. As such, it makes it difficult for professional advisors to bring certainty to every individual case. 6

One final note of warning Where the new construction is zero-rated, there is a 10 year claw back mechanism. If activities switch from being non business to business or the building is subsequently sold or leased, the taxpayer must account for an appropriate amount of VAT at the standard rate, based on the amount of business use and how far through the 10 year claw-back period the change in use occurs. This is achieved by means of a deemed self supply. Appropriate procedures should be put in place to monitor this year on year. In particular, charities should be aware that simply exceeding the 5% de minimis limit can trigger this charge. For further information, reference should be made to HMRC Public VAT Notice 708 Buildings & Construction (August 2014), Chapter 19 Changing the use of certificated buildings. 7