Increasingly, charities are working together to create efficiencies and add value; however, the fact that VAT can get added to the cost as one charity charges another for services has acted as an impediment to collaborative working.

European law provides an exemption for certain services supplied within cost-sharing groups whose members carry out exempt and/or non-business activities: it was implemented in UK VAT law with effect from 17 July 2012. For further information see HMRC’s VAT Cost Sharing Exemption Manual.

The exemption applies when two or more organisations with exempt and/or non-business activities join together on a co-operative basis to form a separate, independent cost sharing group (CSG) to supply themselves with certain services at cost and exempt from VAT. It does not apply to the supply of goods. It is designed to help organisations such as charities, housing associations, universities and further education colleges to collaborate to share resources without being deterred by the cost of VAT on any recharges.

There are five conditions attached to the exemption:

1) There must be an ‘independent group of persons’ (a CSG) supplying services to persons who are its ‘members’. A CSG is an independent group of persons that is separate from its members, but who work together. It can be a group of equals or, if all the members agree, one or more members can have effective control and/or majority ownership of the group. It must be a separate taxable person from its members in order to be able to make exempt supplies for VAT purposes to its members. The CSG must have at least two members. For example, if the CSG is set up as a limited liability partnership, it will be possible for one of the members to control more than 50 per cent of it. Provided that all the relevant conditions are met, this could enable the CSG to be included in the same VAT group as one of the members.

2) All the members must carry on an activity that is exempt from VAT or which is not seen as being a business activity for VAT purposes. HMRC considers that a member should have either:

• 5 per cent or more exempt and/or non-business supplies in the immediate 12 months prior to joining the CSG or
• In its last completed partial exemption, business/non-business year prior to its membership of a CSG, 5 per cent or more exempt and/or non-business supplies have been made

If, at the time of joining a CSG, a member has not made 5 per cent or more exempt and/or non-business supplies, it must have a clear intention of receiving and must receive qualifying services which are ‘directly necessary’ from the CSG in the 12-month period starting from when the member joined the CSG. These supplies must also be directly utilised within 12 months of receipt by the member to make 5 per cent or more exempt and/or non-business onward supplies.

3) The services supplied by the CSG to which the exemption applies must be ‘directly necessary’ for the use by the members in their own exempt and/or non-business activity. HMRC will accept that services are ‘directly necessary’ if they are identified as follows:

• Only supplies of services received from a CSG that can be ‘directly attributable’ to the member’s exempt and/or non-business activities will be regarded as ‘directly necessary. Expenditure on services attributable to both taxable and exempt and/or non-business activities will not qualify.
• Where a member of a CSG has wholly exempt and/or non-business activities or negligible levels of taxable activity, all the supplies that they receive from a CSG will be regarded as ‘directly necessary’ for those exempt and/or non-business activities. ‘Negligible’ means less than 15 per cent; therefore, where a member of CSG has exempt and/or non-business activities that form 85 per cent or more of its total activities, all the supplies it receives from their CSG will be regarded as ‘directly necessary’.

4) The CSG must only recover from its members the members’ individual share of the expenses incurred by the CSG in making the exempt supplies to them. This includes any general overheads incurred by the CSG in providing services to its members as well as any discounts received or input tax recovered by the CSG. The CSG will be allowed to build up a surplus to cope with timing differences between receiving contributions from members and paying expenses.

5) The application of the exemption to the supplies made by the CSG to its members must not be likely to cause a distortion of competition. This means that it must not be an outsourcing arrangement and must not exist or compete in a market.

While the introduction of the exemption in the UK was welcome, its adoption is not currently widespread. The strict conditions of the exemption mean that it is not suited to many charities’ structures and operations. The infraction proceedings against Luxembourg for its (similar) implementation of the exemption have also caused further uncertainty over the longevity of HMRC’s interpretation of the ‘directly necessary’ condition, and hence the long term benefit of the exemption.