What Charities Should Know About VAT Planning

For charities in the UK, VAT treatment often differs from other organisations due to the mix of non-business, exempt, zero-rated, and taxable activities they carry out. A frequent misunderstanding is that charitable status removes VAT obligations altogether, when in practice, charities remain subject to VAT rules in many areas. The way income is generated, how costs are incurred, and how activities are structured all influence the amount of VAT that can be recovered and reported to HMRC.

Effective VAT planning focuses on understanding how partial exemption applies and how the de minimis rules affect VAT recovery. By reviewing income streams and expenditure in detail, charities can determine which costs support taxable activities and which relate to exempt or non-business use. This allows them to identify the level of VAT recovery permitted under the rules and to optimise recoveries where possible.

At The VAT People, we specialise in advising charities on their VAT obligations and are experts in tax regulations. In this guide, we explain how charities can apply the de minimis rule correctly, assess entitlement to VAT recovery, and structure activities in a way that supports compliance with HMRC's requirements while improving financial efficiency.

VAT registration for UK charities

A charity must register for VAT with HMRC when its taxable turnover from business activities exceeds the £90,000 registration threshold in any rolling 12-month period. Taxable turnover includes income from standard-rated, reduced-rated, and zero-rated supplies, but excludes exempt income and income that falls outside the scope of VAT, such as pure donations with no benefit provided in return.

In practice, identifying what counts as taxable turnover can be less straightforward for charities, as many operate a combination of trading activities, fundraising events, and grant-funded projects. Some income streams may appear charitable in nature but still be treated as taxable business supplies for VAT purposes, meaning they must be included when assessing the registration threshold.

Charities may also choose to register for VAT voluntarily, even when their taxable turnover is below the threshold. Voluntary registration can be appropriate where a charity incurs VAT on costs that relate to making taxable supplies, as registration allows that input tax to be recovered, subject to the partial exemption and de minimis rules. The decision to register voluntarily requires careful consideration, as registration also brings ongoing VAT compliance obligations, including submitting VAT returns and applying the correct VAT treatment to income and expenditure.

The challenge of partial exemption

Many charities generate income from a combination of taxable and exempt activities. Where this happens, the charity is treated as partially exempt for VAT purposes. Partial exemption affects how much input VAT can be reclaimed and requires charities to distinguish carefully between different types of income and expenditure to enable accurate VAT reporting.

Taxable supplies include goods and services that fall within the scope of VAT, even where the rate charged is 0%. This covers standard-rated, reduced-rated and zero-rated supplies, such as retail sales, catering, advertising, and some fundraising activities that involve a clear supply in return for payment.

Exempt supplies are activities that are specifically exempt under VAT legislation. For charities, this can include certain fundraising events, education and training, and some cultural or welfare services, provided the conditions for exemption are met. VAT is not charged on exempt supplies, but they do not support full recovery of VAT on related costs.

When a charity is partially exempt, input VAT recovery depends on how costs are used:

• VAT on costs that relate solely to making taxable supplies is normally recoverable.
• VAT on costs that relate only to exempt supplies is generally blocked from recovery.
• VAT on overheads and shared costs that support both taxable and exempt activities must be apportioned using a partial exemption method. Only the proportion attributable to taxable supplies can be reclaimed.

Applying these rules correctly requires accurate records and a clear understanding of how activities and costs interact. Errors in allocation or apportionment can lead to over-claims or under-claims of VAT and potential challenges from HMRC.

Apportioning input tax

Where costs support both taxable and exempt activities, a charity must apportion input VAT to calculate the amount that can be reclaimed. The default position is to use the standard partial exemption method, which allocates recoverable VAT by comparing the value of taxable supplies with total supplies for the VAT period. While this approach is straightforward, it is based on income values and does not always reflect how costs are actually used within a charity.

If the standard method does not produce a fair and reasonable result, a charity can apply to HMRC to use a Partial Exemption Special Method. A special method is designed to provide a more accurate reflection of the use of costs between taxable and exempt activities. It can be based on objective criteria such as staff time, floor space, transaction volumes, or a combination of measures, depending on how the charity operates.

Using a special method requires formal approval from HMRC. The application must explain why the standard method is not appropriate and demonstrate how the proposed method better aligns VAT recovery with actual use. Once agreed, the special method must be applied consistently across all relevant costs and accounting periods, and any changes to activities or cost structures may require the method to be reviewed or re-approved.

What is the de minimis rule for VAT?

The de minimis rules provide an exception within the partial exemption framework. They allow a business to recover all its input tax, including the portion that relates to exempt supplies, if that amount is below certain limits. For charities, meeting the de minimis threshold can significantly reduce the administrative burden of partial exemption calculations and improve VAT recovery.

A charity is considered de minimis and can recover all its input tax if it passes any one of the three available tests for the relevant period.

• The original test: the exempt input tax incurred is no more than £625 per month on average AND is less than 50% of the total input tax incurred in the VAT period.

Since April 2010, two simplified tests have been available that supplement the original test:

• Simplified Test One: the total input tax incurred is no more than £625 per month on average, AND the value of exempt supplies is no more than 50% of the value of all supplies.
• Simplified Test Two: the total input tax incurred, less input tax directly attributable to taxable supplies, is no more than £625 per month on average, AND the value of exempt supplies is no more than 50% of all supplies.

Once the exempt input tax has been calculated, a business is treated as de minimis if it meets the conditions of any one of the available tests. In practice, this means a charity will first consider test one. If test one is met, the business is de minimis and all input VAT, including exempt input tax, can be recovered.

If test one is not met, the charity can then consider test two or the original de minimis test. Passing either of these tests is sufficient for the business to be treated as de minimis. There is no requirement to pass more than one test – meeting the conditions of any single test is enough.

Where a charity does not pass test one or test two, the calculations carried out are not wasted. The figures already identified for exempt input tax and total input tax are still used when applying the original de minimis test. If the charity fails all of the de minimis tests, it is not treated as de minimis and must restrict recovery of exempt input tax in line with its partial exemption calculation.

The annual de minimis test

Charities that were de minimis in their previous partial exemption year can provisionally treat themselves as de minimis in the current year. This allows them to recover all input tax on their VAT returns without performing quarterly partial exemption calculations.

However, this simplification carries risk. A full annual review is mandatory. If the charity fails the de minimis test at the year-end, it must repay all the input tax on exempt supplies that was provisionally recovered. Therefore, if a charity anticipates its circumstances changing and it fails the test, this provisional treatment is not advisable.

Important considerations charities should make about VAT planning

Beyond partial exemption, VAT planning for charities often involves reviewing how specific activities and reliefs are applied in practice. Decisions taken in these areas can affect both the VAT charged on income and the amount of VAT that can be recovered on related costs.

• Fundraising exemption: applying the fundraising exemption means no VAT is charged on income from qualifying fundraising events. However, this also blocks recovery of input VAT on costs directly linked to those events. In some cases, it may be more beneficial to structure an event so that one of the exemption conditions is not met. This can result in the income being treated as taxable, potentially at the zero rate where the activity qualifies, which may allow related input VAT to be reclaimed. Any change in approach should be reviewed carefully to confirm the VAT treatment and ongoing compliance position.
• Special VAT reliefs for charities: charities may be entitled to a range of VAT reliefs on purchases, provided the relevant conditions are met. These can include:
• reduced-rate VAT at 5% on fuel and power used for non-business purposes or where usage falls within the small-scale limits.
• zero rating on certain supplies, such as disability aids, advertising for charitable purposes, and the construction or conversion of buildings intended for qualifying charitable use.

Applying these reliefs correctly often requires clear records and, in some cases, the completion of valid declarations to support the reduced or zero rate applied by suppliers.