Grants which are freely given will be classified as non-business. They should not be a purchase of services, although the funder may attach conditions or specify the purpose for which the grant should be used. This means that no VAT has to be charged on the grant sum but it also usually means that no VAT on related purchases may be recovered. So in practice , when planning a budget for a grant-funded service, a charity needs to ensure that it includes VAT on relevant expenditure.

There have been particular difficulties with establishing the VAT category that applies to a range of funding agreements that have grown up between government bodies and voluntary organisations.

In general, for a funding agreement to be considered a business activity for VAT purposes:

• There should be a direct link between a particular payment and a particular service
• There must be a legal relationship between the parties involved
• There should be consideration (payment) for the service

A contract will likely be considered a business activity if the public authority is purchasing a service from the voluntary organisation.

A grant will not be a business transaction if it provides a subsidy for a service provided to others.

It should be noted however, that it is the actual arrangement between the funder and charity that is potentially liable for VAT, not what that arrangement is called (grant or contract). However, the circumstances of each situation will affect exactly how it should be treated. If in doubt, then seek a ruling from your local VAT office.

Broadly, these are the likely indicators:

The consequences of a change from grant to contract arrangement may be quite complicated for some organisations. If you change from providing services under grant to a contractual basis you may have to register for VAT and budget for your costs in a different way. On the other hand, many services provided by charities are exempt and so no VAT has to be charged. More information about this is available from our section on taxation.