Public bodies outsourcing services to charities do so either by making grants to charities or by paying fees to charities under contracts.

In some cases the choice between a grant and a contract can, because of the VAT rules, make a real financial difference to a charity.

The Charity Tax Group has published guidance explaining the VAT consequences of both grants and contracts.

John Hemming, chairman of Charity Tax Group, said: “The Charity Tax Group doesn’t as a matter of principle favour contracts over grants or grants over contracts. Our role is to explain clearly to charities and public sector commissioners what the different VAT implications are of the two methods of funding.

"It is then for funder and funded to decide which is right in their circumstances. Tax-efficiency should not be the determining or the main factor, but it should be one of the factors to be weighed in the balance.

!We think it would be irrational not to take into account the tax consequences of different funding methods since it might mean that charities were failing to make the most efficient use of their resources. CTG’s new guidance helps charities to go into it with their eyes open.”

Some services – such as social welfare care and medical services, the care of children and the elderly, and education – are exempt from VAT.

A public body procuring an exempt service from a charity does not pay VAT on the cost of the service.

Equally the charity cannot recover the VAT on its costs attributable to preparing and delivering the service.

That is true whether the public body gives the charity a grant or pays it fees under a contract. Where the service is an exempt service the charity’s VAT position is the same under a grant as under a contract.

For services which are not exempt, however, the charity’s position is different between grants and contracts.

This is because the making of a grant does not count as a business transaction for VAT purposes.

The services supplied by the charity using the grant money do not therefore count as a taxable supply, and the charity is not entitled to recover the VAT on its costs attributable to preparing and delivering the service.

If in the same circumstances the charity was receiving fees under a contract, rather than a grant, it would be entitled to recover the VAT on its attributable costs.

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