Grant income vs. payment for supply

One of the primary challenges is determining whether a receipt of money is a grant (outside the scope of VAT) or a payment for a supply (subject to VAT). A payment for supply can be made by the beneficiary of the supply or by a third party. If a funder is paying for specific services or goods to be supplied to themselves or other named parties, this will be considered a supply subject to VAT.

HMRC guidance on grants

It’s essential to carefully consider the factors that determine whether a payment is classified as a grant or as a payment for supply. We are happy to discuss these factors with you to ensure proper classification.  See also our download “Is there VAT on my grant income?”.

Mixed funding projects

Some projects may be partly funded by the beneficiary (treated as a VATable supply) and partly by grant funding (treated as outside the scope of VAT). HMRC has provided examples showing that such projects can potentially have a VAT invoice raised for the entire value of the supply, including the grant-funded element. For instance, if a project is worth £100,000 and is funded by £20,000 from the beneficiary, £70,000 from a grant, and £10,000 from general grants and donations, a VAT invoice should be raised for £90,000 (the direct payment and specific grant).

Under declaration of VAT output tax

If any items have been treated as grants (no VAT) but could be supplies, you need to consider your response. This will depend on the strength of the evidence supporting the classification as a grant or a supply. Some income treated as grants may need to be reclassified, and output tax (VAT on sales) will need to be declared to HMRC, with additional VAT paid. It is better to self-declare than have HMRC find an error, as penalties could be significantly higher.

Reclaiming VAT input tax

VAT cannot be reclaimed on non-business activities. If you receive grant funding directly for a project, this is not a business activity, and the input tax on costs related to that project cannot be reclaimed. For expenses related to both business and non-business activities, the input tax claim must be apportioned on a “just and reasonable” basis. A common approach is to restrict input tax based on the grant and sales income split.

However, if a project is commercial but funded by a mixture of sales income and grant funding, the input tax on supplies bought for the project can be reclaimed.  This is the case even if the sales income hasn’t started to materialise yet.

Conclusion

Getting the VAT right on grant income and related expenses can be a bit tricky, but it’s super important to stay on top of it to avoid any issues with HMRC. At Green Accountancy, we’re here to make things easier for you. Whether you need help figuring out if your grant is VATable or how to reclaim VAT on your expenses, we’ve got you covered.

Feel free to reach out to us with any questions or if you need more guidance. We’re always here to help you navigate the complexities of VAT and keep your business running smoothly.