This article was first published in the September edition of Charity Finance magazine’s Brexit special.

It is now two months since the EU referendum and the UK’s decision to leave the EU. While the full implications of Brexit are still uncertain, it is possible that, whatever settlement is reached, there will be significant implications for the tax treatment of charities in the long term.

This includes both opportunities and threats; and the sector therefore needs to ensure that its voice is heard by Government during the Brexit negotiations. At the same time, until Article 50 is triggered and the exit from the EU is finalised the UK remains a full member of the EU and we carry on as at present.

VAT implications

The area of charity taxation where Brexit is likely to have most impact is VAT. VAT is a European tax, with overall policy decisions made at European level, leaving the UK Government limited scope to make unilateral policy changes. In theory, Brexit offers the Government a major opportunity to re-invent the VAT system. But will change be that radical? While the Government may ultimately consider a move to a GST-type system (though it is not at all clear why it should do so, given the administrative upheaval that a change would cause), it seems inconceivable that the UK would simply abandon the existing VAT system, at least in the short term, not least because of the revenue generated. The future structure of the VAT system in the UK is also likely be determined by the nature of the ongoing trading relationship with the EU and any concessions that may be needed to retain access to the Single Market – a consistent approach on VAT and compliance with EU State Aid rules could yet be two of them. In that connexion, it should be noted that both Iceland and Norway, though outside the EU, operate VAT regimes.

It therefore seems likely that the VAT system will largely be retained in its current form, albeit with opportunities to make significant changes at the margins. But there is the risk that the Government will wish to reduce the number of zero-rates; and many regard the current inability to reinstate zero rates once they have been withdrawn as providing additional protection to existing zero rates. Once that protection disappears, the Government may wish to target those areas that currently benefit from relief.

Sector priorities

So what are the priorities for the sector? Charities benefit from invaluable zero rates and important exemptions, yet they still face an irrecoverable VAT burden of up to £1.5bn a year. Major priorities are clearly to protect existing charity zero rates and encourage Government to consider new ones. Ironically, the European Commission’s latest Action Plan on VAT includes serious proposals to give more flexibility to Member States on VAT rates, including the prospect of new reduced and super-reduced rates.

Charities will therefore need to present strong economic arguments in favour of existing and new zero rates. Simply arguing for a “fairer” system (whatever that might mean, fairness often being in the eye of the beholder) will not be sufficient: any proposal will need to demonstrate its wider benefits to society and that it will be fiscally-neutral for the Exchequer.

Charities will wish to continue to seek significant structural reform of the VAT system, which has inherent distortions that prevent charities from operating on a level playing field with businesses and the public sector – even though this could be pushing against a resistance from Government to any radical reform. This might be in the form of much wider zero rates and super-reduced rates (possibly at the expense of exemptions); and CTG is working with its VAT Expert Group to prepare representations to the Government on behalf of the sector.

European legal judgments

Another important question relates to the status of precedents based on decisions of the CJEU. On leaving the EU, the CJEU would no longer have jurisdiction and its future decisions would not be binding on UK courts. This opens up opportunities for HMRC to clarify important principles such as the VAT business/non-business distinction, which has been clouded by inconsistent and unclear recent CJEU case law.

It seems likely, however, that if we retain any laws originating from the EU (which is probable) our courts would still take account of future CJEU judgments as persuasive, even if not binding, when ruling on those laws. At the moment, the domestic courts are required to ‘take into account’ the judgments of the European Court of Human Rights even though they are not bound by them: post-Brexit, it is not inconceivable that they could adopt the same stance in relation to the CJEU even if they were not directed to do so by statute.

It remains to be seen what other legislation originating from the EU will be removed. In response to the CJEU judgments in Persche and Stauffer, Finance Act 2010 extended UK charitable tax reliefs to eligible charitable organisations in the EU, Norway and Iceland that are equivalent to UK charities. Given that regulation of foreign charities is often far less rigorous than in the UK, HMRC had to respond by introducing the “fit and proper person” test to protect the integrity of tax relief.

However, in practice this rule has proved cumbersome and ill-targeted, with revisions to the guidance continually delayed. Evidence from HMRC suggests that very few claims for UK tax relief have been received: so, unless the UK is required to maintain “free movement of reliefs” as part of any negotiations, it is conceivable that this legislation may be repealed.

Understanding the landscape

A lot is still to be decided and at this point we can only speculate: but charities need to ensure that they identify the wider benefits of EU membership that need to be protected as well as the disbenefits that should be jettisoned. In particular, they need to identify opportunities for reform of the charity tax system in what will be a once-in-a-lifetime shift in law-making in the UK. CTG is urging all charities to undertake such an evaluation and to share their findings with the Group. This will ensure that the submissions that are made on behalf of the sector are as representative as possible.

John Hemming is Chairman of the Charity Tax Group