Socrates Socratous examines where are we now with this thorny issue.
The question of whether a charity can reclaim the VAT it has incurred on investment management fees has remained unanswered for a number of years. It was hoped that the recent First-Tier Tribunal decision involving the University of Cambridge would bring some certainty to the issue, however this has proved not to be the case, as it is understood that HMRC has appealed the decision to the Upper-Tier Tribunal.
Charities had first hoped to be able to reclaim a proportion of the VAT that they incur in relation to investment management fees following the High Court judgment in the Church of England Children’s Society (CECS) case back in 2005. CECS had incurred VAT on its fundraising costs and in particular on the services of street canvassers who sought to raise donations for the charity. The High Court ruled that these costs related in part to the general taxable business activities of CECS and therefore the VAT should be treated as a general overhead and partly recoverable. It relied on the principles established in the ECJ case of Kretztechnik (C465/03) in reaching its decision (see below).
HMRC issued Business brief 19/05 setting out its position following the CECS judgement. It advised that where funds are raised solely for a restricted charitable purpose involving wholly non-business activities, the VAT incurred on fundraising is not input tax and therefore is not recoverable. Conversely where the funds are used at least in part to support the making of taxable business supplies, the VAT is input tax and will be partly recoverable subject to the partial-exemption position of the charity. HMRC therefore appeared to accept that it is the use of the funds that should determine recovery of VAT on fundraising costs. The issue of the business brief led to a number of charities submitting retrospective claims to HMRC, both in relation to fundraising costs and to investment management fees.
Some of these claims were initially paid, but it also became apparent that others were being withheld as HMRC believed the raising of funds via investment management was non-business. HMRC’s view seemed to have changed since the initial guidance was issued.
University of Cambridge
In August this year the First-Tier Tribunal gave its decision in Chancellor, Masters & Scholars of the University of Cambridge v HMRC. It decided that VAT incurred on investment management fees could be treated as input tax and partly recoverable. The background to the case is summarised as follows.
The University of Cambridge receives donations which are invested in the Cambridge Endowment Fund. The Fund invests in a range of securities including equities, property, bonds and cash deposits. The income generated from the fund is distributed across the university to support all of its activities. These activities could be taxable, exempt or non-business.
The fund incurred third-party administration and management costs, some of which were liable to VAT, and the dispute concerned whether the VAT on these costs was irrecoverable, as HMRC had ruled, or related to the entire activity of the university, and therefore partly recoverable as residual VAT under the university’s special partialexemption method.
Crucially, it was common ground that the activities of the endowment fund did not constitute an economic activity for VAT purposes. This was important because it distinguished the Cambridge case from a previous case involving NSPCC. NSPCC had argued that its investment activity was a business activity and sought to reclaim a proportion of the associated VAT costs. The tribunal found in favour of HMRC deciding that it was not appropriate to treat NSPCC’s investment activities as a business.
In Cambridge, it was accepted that the supplies made by the fund were not made in the course or furtherance of a separate investment business and therefore it would be inappropriate to include such income within an apportionment calculation. Cambridge said that the income generated each year from its investment activities was used solely to provide funds to support the normal activities (taxable and exempt) and non-business activities of the various departments within the university. The purpose of the fund was therefore not to run a parallel and distinct investment activity, but to generate funds that facilitated and supported the overall operation of the university.
The university relied on the ECJ decision in Kretzechnik in which it was decided that costs in relation to a share issue leading to a listing and raising capital should be treated as overheads despite the fact that the share issue itself was not an economic activity. The university argued that Kretzechnik had established that although expenditure might have been incurred for operations which were not necessarily within the scope of VAT, provided it can be shown that the operation was carried out for the benefit of economic activities in general, the expenditure was overhead expenditure and as such partly recoverable.
Counsel for the university referred to one simple question – for what purpose has the operation not falling within the scope of VAT been carried out? If it has not been carried out for its own purposes, but rather to support the general activities of the taxable person, then the VAT incurred is overhead VAT. The university also relied on the CECS case and the guidance contained in HMRC’s business brief.
HMRC sought to rely on the BLP Group (C-4/94) in which it was decided that where a share disposal was intended to raise capital to be used for the benefit of a taxable business in general, the VAT incurred on the costs of the disposal were not recoverable, because the exempt disposal of shares broke the chain of connection between the costs and the taxpayer’s taxable activities. HMRC argued that, although it accepted that the university’s endowment fund’s investment activities were not business activities for VAT purposes, they were technically capable of being supplies and the nature of those supplies was exempt, hence there should be no VAT recovery. HMRC’s view was that the endowment fund was a freestanding non-business activity which could not be ignored and the costs of managing the fund’s investments had no direct and immediate link with the university’s business activities.
The tribunal found in favour of the university and agreed that Kretztechnik applied. There was a direct link between the university’s investment activity and its overall economic activities. The purpose of the non-economic activity was to benefit the university’s general business activities, therefore those costs were overheads of those activities and the VAT incurred was partly recoverable. The tribunal considered that the investment activity was not carried on for its own sake so that it was a freestanding activity. The endowment fund was carried on for the benefit of the university’s economic activities.
TLLC Ltd
But no sooner had the ink dried on the Cambridge case, along came the decision of TLLC Ltd which is the representative member of a VAT group carrying on the Travelodge hotel business.
TLLC entered into a sale and leaseback with a third party which involved the sale of hotels and shares in subsidiary companies which held 199 hotel properties. It incurred VAT on the professional fees and sought to reclaim that VAT as attributable to its general business activities. HMRC disallowed the claim on grounds that the services had a direct and immediate link to the exempt disposal of shares.
TLLC ran three arguments in the tribunal, one of which was that the holding and sale of the subsidiaries was not an economic activity and therefore VAT was recoverable as a general overhead cost. Unfortunately, the tribunal found that the disposal of the shares was an economic activity that was exempt, and hence there was no entitlement to VAT recovery. However, the tribunal added that even if it was wrong on this point and the disposal was not an economic activity, TLLC could still not recover the VAT incurred on raising funds. The absence of an economic activity did not mean that the input tax could be treated as an overhead cost. This seems to contradict the finding in Cambridge and it will come as no surprise to hear that HMRC has appealed the Cambridge decision.
Any charity that has submitted a retrospective claim in relation to VAT incurred on investment management fees and has yet to be repaid is likely to now have to wait a little longer for a final decision on whether repayment will be made.
However, any charity that has yet to lodge a claim may well want to do so now to ensure that its claim is protected against the four-year cap. Given that litigation on this matter is set to continue, waiting for certainty may well result in a reduced repayment in the event of a successful outcome for the taxpayer.
Socrates Socratous is the director of SOC VAT Consultants.
