One of the key considerations when charities are receiving funding from third parties, which are clearly not unfettered donations, is to establish whether the monies being received are a grant or a contract. There are legal, accounting and tax ramifications depending on the answer.
Contracts
Contracts are legally binding agreements which will specify the goods or services to be supplied, with an agreed price, and listing the standard service criteria. The payments made will usually be subject to VAT, however:
- the VAT status depends on the services or goods being supplied and whether any reliefs would be available, such as with welfare services provided.
- Where the contract relates to a taxable supply, VAT incurred on the expenditure can be reclaimed by the charity.
For accounting purposes income is generally recognised once the contractual obligations have been fulfilled. Where the contract is still in progress, income will be recognised to the extent that it has been earned, which usually gives rise to accrued or deferred income in accounts.
Grants
In contrast, grants are freely given with the funder not expecting anything in return. However, if the grant is given for a specified purpose, any unspent monies may have to be returned to the funder. In some cases, depending on the status of the funder, Gift Aid may be applicable on grants given to charities. Grants are outside the scope of VAT because they don’t constitute a payment for the supply of a service, and activity wholly funded by a grant is classed as a non-business activity, therefore VAT incurred on the expenditure cannot be reclaimed. For accounting purposes;
- For unrestricted grants, the accounting treatment is to recognise these in full once certain and measureable.
- For restricted grants, where the funds do not clearly relate to a future period, any unspent balance at the year end is carried forward in reserves.
- Therefore, income recognition does not match income to expenditure incurred.
HMRC has issued guidance on how to determine whether the amount received relates to a contract or a grant. Questions that need to be asked include whether the funder receives anything in return for the funds (and if not, does a third party with a direct link to the funder benefit)?
The issue often arises with government or local authority funding and can be quite subtle in its distinction. For example, a local authority could give a grant to a charity to provide a number of subsidised places or alternatively the local authority could purchase a certain number of places to be able to provide to its users – which could result in different treatments. Therefore it is important that any “agreement” is carefully considered by the charity so that it is clear about its interpretation. Be careful: just because an agreement states that it is a grant agreement does not necessarily mean that it is one – it could be a contract. The interpretation is dependent on the terms and conditions attached, not the title given to the document.
It is also important to consider whether you would prefer a grant agreement or a contract. The funder may be able to structure the agreement differently depending on your circumstances and preference. And, finally, consider adding clauses to agreements, specifying that the appropriate VAT treatment applies. This means that if subsequently the treatment is successfully challenged, VAT may be able to be recovered from the original funder.
For more information on this, please contact Simon Brown on 0191 285 0321 or email simon.brown@taitwalker.co.uk.
