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Changes to policy on zero-rating VAT for charitable use

The VAT extra statutory concession 3.29, which allows charities to ignore small amounts of non-qualifying use (up to 10 per cent) when deciding whether the construction of a new building qualifies for zero-rating, is being phased out.

The current concession is based on the time the whole building or parts of the building are used; the number of people using the building or floor space.

Furthermore, the normal payback provision (requiring charities to pay VAT to HMRC to the extent that, within 10 years of obtaining zero-rating, any part of the building is put to non-qualifying use), does not apply where ESC 3.29 was used in the first place.

HMRC have now reviewed this issue and reached the conclusion that ‘solely for a relevant residential or relevant charitable purpose’ in law should automatically allow for a de minimis amount of non-qualifying use.

The new application of this interpretation means that the statutory definition (not the ESC) is still fulfilled if the relevant use by the charity is 95 per cent or more. The good news is that charities can measure the ‘up to 5 per cent’ non-qualifying use by any fair and reasonable means, without prior reference to HMRC, but the obvious bad news is that only 5 per cent non-qualifying use can now be ignored, instead of 10 per cent. HMRC will obviously be able to challenge a charity’s view of ‘fair and reasonable’.

ESC 3.29 is no longer considered necessary and will be withdrawn but for a transitional period of a year from 1 July 2009, charities may still use it or choose the new rules, whichever they prefer.

Two related concessions: the ‘switching areas’ and ‘look through’ concessions, will also be withdrawn on the same time scale.

It is important to note that if charities choose the new rules in the transitional year from 1 July 2009 to 30 June 2010 and when they have to apply them thereafter, any change of use in the 10 years from obtaining zero-rating will trigger the payback provisions.

Charities should ensure they understand the new provisions and the interpretation of ‘solely’ before issuing zero-rate certificates to main contractors.