UK foundations and charities are likely to lose their ability to reclaim VAT on fund management fees, following a judgement by the Court of Justice of the EU (CJEU).
The ruling also means that charities could forfeit VAT reclaims on their fundraising activities.
It is expected that this could cost the largest UK charities, including some endowment funds, more than £1m (€1.1m) a year each in extra tax.
Until 2005, UK charities had been unable to reclaim VAT on fund management fees or fundraising activities, but a CJEU decision that year held that a German trading company, Kretztechnick, could reclaim VAT on the costs of a rights issue because the funds raised from the sale of the shares were used in furthering the making of taxable supplies by the business.
The Children’s Society, a UK charity, then used Kretztechnick in a successful appeal in the English courts against a decision by HM Revenue and Customs (HMRC) to refuse a VAT reclaim on the cost of fundraising services.
Many UK charities have used these decisions to enable the partial recovery of VAT on fundraising costs, and the principle has been extended by some to enable the partial recovery of fund management fees on the basis the investments are used to help further VAT-taxable supplies.
However, Cambridge University – whose £3.2bn endowment fund finances university posts and activities – has lost an appeal against HMRC in the EU’s highest court to reclaim VAT on investment management fees.
The CJEU said that, unlike with Kretztechnick – whose rights issue was used solely to fund its business activities – the costs of the university’s endowment fund were not an overhead of the business activity of the university because the fund is used for various charitable purposes, and therefore no VAT could be recovered.
Legal experts said there was a wider concern that HMRC could use this decision to refuse VAT reclaims on charities’ fundraising costs.
Bill Lewis, consultant with law firm Bates Wells, said: “The inability to reclaim VAT on management fees is a blow to the charity sector and especially the bigger endowments.”
He continued: “The concern now is that HMRC will say charities cannot recover VAT on fundraising costs, because there are very few that do nothing except carry out VAT taxable business activities.”
However, Lewis said that HMRC was unlikely to claw back VAT that had previously been repaid, as it had issued guidance confirming that it would allow VAT reclaims on fundraising costs following The Children’s Society ruling.
If the UK leaves the EU Customs Union as a result of Brexit, there is a question as to whether either case will continue to be relevant in the UK. However, Lewis expected EU VAT rules to remain relevant for some years to come.
“But if the UK leaves the Customs Union there is an opportunity for the UK to create its own VAT rules without reference to the EU,” he added. “This will require the sector to lobby ministers for as many VAT advantages as possible to be put into UK law.”