Essential Finance – Exemption that proves the rule

An organisation?s governance structures can have a significant impact on its position with regard to VAT. Steve Hodgetts explains.

You may have noticed various stories in the press over recent months highlighting the problems being encountered by arts charities such as theatres and orchestras following a landmark VAT ruling from the European Court of Justice (ECJ).

The ECJ decision was the culmination of a lengthy legal wrangle arising from a dispute between HM Customs and Excise (now HM Revenue and Customs) and London Zoo over the interpretation of EU law exempting certain cultural bodies from VAT. It was a landmark decision because it overturned existing UK law, which had failed to correctly interpret EU law, and granted the Zoo the right to treat its admissions income as exempt from VAT, resulting in overall savings for the Zoo. It also opened the way for many other ?cultural bodies? to claim similar VAT exemption.

Most recently Bournemouth Symphony Orchestra (BSO) has been in the news following the failure of its appeal to the High Court against a Customs decision that its ticket income should be subject to VAT. BSO?s failure to meet the criteria for exemption is likely to cost the organisation in excess of £150,000, and other orchestras, galleries, theatres and zoos could be similarly affected.

Governance

For those working in these types of bodies, it is important to know how the VAT exemption works (and whether VAT exemption is beneficial depending on the specific circumstances). It is also vitally important to understand the impact of the governance structure on the VAT position, to which end the following notes may be of use.

Admissions to events are normally subject to VAT, but, exceptionally, admissions to: a museum, gallery, art exhibition or zoo; or a theatrical, musical, or choreographic performance of a cultural nature, can be exempt from VAT when provided by a public body, or an ?eligible body?. The definition of ?eligible body? is key. An eligible body must be both non-profit making (where any profits made cannot be distributed, but must be re-invested in the activities of the body), and ?managed and administered on a voluntary basis by persons who have no direct or indirect financial interest in its activities.? It is the interpretation of what constitutes ?managed and administered on a voluntary basis? that is the vexing part. Returning to London Zoo, this is run on a day-to-day basis by a number of paid employees who take care of the animals, etc , and on this basis it had previously been viewed as outside the exemption. This position was challenged by the Zoo, however, because in EU law it states that the exemption applies to bodies ?managed and administered on an essentially voluntary basis?. This was the point that was considered by the UK courts, and, ultimately, by the ECJ.

In its analysis, the ECJ drew a distinction between the taking of key policy decisions and the implementation of them, and ruled that the requirement to be managed and administered on an essentially voluntary basis in EC VAT law referred to management by: those persons designated to direct the body at it highest level according to the constitution, and those who, in fact, take the decisions of last resort ? especially in the financial area ? and carry out the higher supervisory tasks. Conversely, it did not refer to those persons carrying out the day-to-day operational activities that merely gave effect to the policy already laid down.

Eligibility

Broadly speaking, this is interpreted to mean that a body is eligible if it is run by unpaid trustees. However, BSO found to its cost that it is not that simple. In its specific case, one of its trustees is also the Managing Director, which has created the problem. Although BSO?s Managing Director is not paid for his trustee duties, he is paid for being the Managing Director, and the High Court decided that his presence on the board meant BSO was not ?managed or administered on an essentially voluntary basis?.

BSO intends to appeal against this decision, but in the interim arts charities need to consider their own positions carefully. Those seeking to benefit from the exemption will need to ensure that the higher executive decisions are the responsibility of trustees who have no financial interest in the activities of the organisation. This means trustees not having dual roles, as both trustee and employee or paid adviser, but case law also indicates (in Longborough Festival Opera) that a trustee standing as guarantor for the losses of the charity can create a ?financial interest? (as it encourages the trustee to ensure the organisation is run commercially so as not to make a loss).

All arts charities should be reviewing the VAT position to determine whether the organisation could benefit from the exemption, and then reviewing the structure of the organisation to ensure the conditions for exemption are met. It is worth noting, however, that in certain circumstances a charity can benefit from treating admissions income as taxable should its structure dictate that it must do so, as the taxable income gives rise to a right to recover VAT on costs that would be denied to the extent that income is exempt.

In simple terms, an organisation that incurs very little VAT on its costs will benefit from having exempt admissions, whereas an organisation that does have a high level of VAT-able costs, or is involved in or planning any expensive refurbishments or building work, may benefit from recovering the VAT on such costs to a greater extent if its admissions income is taxable. Trustees considering their own position may do well to use this as a starting point, but should remember that, as BSO has discovered, it can be less than straightforward, and professional advice may be needed.

Steve Hodgetts is VAT Partner in the Charities and Education Group at Baker Tilly.
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