Recent exemptions to VAT legislation could have a big impact on arts organisations but issues of compliance mean that assessing that impact is not easy. Simon Baxter sheds some light on these developments.
On June 1 2004, HM Customs & Excise gave effect in the UK to the decision of the European Court of Justice (ECJ) in the case of the Zoological Society of London. Customs issued a VAT Business Brief (BB28/03) on December 10 2003 giving guidance on how the exemption would be implemented, but since then affected organisations have been left to their own devices to see if the exemption applies in their own cases, and to deal with the significant compliance issues of VAT exemption.
Does the exemption apply to you?
To qualify for VAT exemption on admission income, an organisation must be managed and administered essentially on a voluntary basis. When the ECJ ruled in March 2002 that London Zoo met those criteria and was entitled to treat admission income as VAT exempt, it became clear that the UK had applied too narrow an interpretation. This decision was a major financial boost for many organisations, which, it seemed, could now reclaim VAT overpaid on such income.
Since then, however, protracted arguments with Customs over whether the exemption conditions have been met have left many affected bodies (particularly those for which the exemption is not good news) facing financial uncertainty. Customs continue to apply a very narrow interpretation of the eligibility criteria. In the recently published decision of the VAT Tribunal in the case of Bournemouth Symphony Orchestra (BSO), Customs successfully argued that the position of the Managing Director on the board of the charity fundamentally affected its ability to treat its admission income as VAT-free. Yet is inconceivable that the BSO is not essentially a voluntary organisation of exactly the type for which VAT exemption was intended.
Another recent decision involving the Zoological Society of Wales provides contrasting guidance on whether an organisation is an ?eligible body?, leaving affected organisations still in a state of flux. Organisations still uncertain of their position should take advice as soon as possible. The financial implications of not doing so can make the difference between future viability and closure.
Making a claim for overpaid VAT
There remains, for many organisations, the opportunity to make a claim for VAT that has historically been overpaid on admission income. However, clearly many have not yet considered (or been able to resolve) the question of recovering what can be considerable sums of money. The ability to make such a claim will continue to exist in relation to overpayments in the past three years and, although uncertainty and discussion with Customs continue, organisations should consider claiming for VAT overpaid back to January 1 1990 when the UK was required (but singularly failed) to implement the VAT exemption for cultural services. Any organisation that has not fully considered whether such a claim would be viable should do so immediately.
Before exemption, the VAT treatment of income and expenditure was relatively straightforward. VAT incurred on costs relating to productions or the purchase of exhibits, as well as building maintenance and operating costs, could be recovered in full. However, hand in hand with VAT exemption for admission income rose the spectre of ?partial exemption?, a process whereby VAT on each item of expenditure must be classified before it can be recovered from Customs. Theatres, producers and eligible touring companies particularly face uncertainty over the VAT treatment of costs incurred on the production of shows. Customs? view is that VAT charged on production costs is wholly attributable to the exempt supply of admission and thus wholly irrecoverable. Clearly, hosting a production for a venue produces both exempt admission income as well as VATable income from sponsorship, programmes, merchandise and food and beverage sales. None of this VATable income could possibly be generated in the absence of the production and therefore the recovery of VAT on production costs should reflect this. Litigation is pending on this and until it is resolved, affected organisations should carefully review their individual circumstances and take advice to ensure their position is protected with Customs.
Partial exemption and capital expenditure
The compliance requirements imposed on any business that generates both VAT-exempt and taxable income are considerable. Whereas the similarly affected financial sector deals with these issues on a daily basis and has the resources to do so, it is the not-for-profit sector that has to deal with what must be some of the most complex record-keeping rules ever drafted. As well as periodic and detailed calculations to determine the level of recovery of VAT charged on overhead expenditure, considerable care must be given to the VAT treatment of capital expenditure projects.
In their Business Brief, Customs? announced transitional arrangements allowing organisations affected by the introduction of the exemption on June 1 2004 to, nevertheless, still recover in full VAT charged, or to be charged, on new building or refurbishment programmes, where the cost would exceed £250,000. However, a condition of this relief was that a meaningful start had been made to the development on or before December 10 2003. Even if soil had not been turned, it would be necessary to demonstrate, to Customs? satisfaction, that detailed contract negotiations had begun. As time goes by, it will be increasingly difficult to satisfy the ?10 December 2003 test?. Organisations planning capital expenditure programmes now must carefully consider how much VAT can be recovered, not when the main contractor arrives to begin work, but at the fund-raising stage. The implications of a £1m refurbishment project increasing in cost by £175k are obvious.
Production contracts and touring companies
Following the introduction of the VAT exemption, there has been considerable discussion on the correct presentation of production contracts. It is not the case that affected organisations are 17.5% better off as a consequence of treating ticket income as VAT-free. As mentioned above, considerable cost arises when VAT can no longer be claimed in full on associated expenditure.
This necessitates careful consideration of the way in which settlements are calculated. Traditionally, the calculation of show settlements started from the premise of box office receipts less VAT. If VAT is no longer payable and reference is instead made to ?gross? box office and if the same calculation is made, venues will be considerably disadvantaged. Venues and producers alike must consider that the offset of VAT on expenditure significantly reduces, and in many cases, eliminates the ability for a venue to pass on any VAT saving to a producer. For many affected venues, the cost of the exemption will actually transform small surpluses into losses.
Looking ahead
The rules on applying the exemption for the supply of cultural services are complex and this article deals with only a few issues the sector faces. No two organisations are the same in the way that the exemption affects their overall financial position. Resources are scarce to deal with the complex compliance requirements of Customs and litigation in the courts is a lengthy and expensive process resulting in sector-wide uncertainty. The best advice is to seek guidance on safeguarding the position of those either benefiting from the exemption, or adversely affected by its restrictions.
Simon Baxter is a Director in the Indirect Tax group of professional services firm Deloitte & Touche LLP providing advisory services to the cultural sector. He is based in Southampton and has considerable experience working with organisations across the sector. Deloitte & Touche LLP is authorised and regulated by the Financial Services Authority. t: 023 8033 4124; e: sibaxter@deloitte.co.uk; w: http://www.deloitte.co.uk