VAT on Grants and Donations: Where the Money Stops Being a Gift

Charities and non-profits receive money from every direction — public donations, corporate sponsorship, grant programmes, service contracts dressed up as grants. VAT treats almost none of it the way the paperwork suggests. What matters is not the label on the payment but whether the payer gets anything in return.

This is one of the most consequential questions in charity VAT, and one of the most frequently got wrong. Treat a taxable supply as a grant and you have under-declared output tax, with interest and penalties running from the date of each receipt. Treat a genuine grant as taxable and you have paid VAT you never owed, and probably over-recovered input tax as well. Both errors compound quietly over years.

The Only Question That Matters: Is There a Supply?

VAT is a tax on supplies made for consideration. A payment falls within the scope of VAT only where there is a direct link between the money and something the payer receives in return. Where no such link exists, the payment is outside the scope of VAT entirely — not exempt, not zero-rated, but simply not a VAT transaction at all.

The principle comes from Tolsma (Case C-16/93), which concerned a street musician who played on the public highway and collected whatever passers-by chose to give. The Court held that the payments were outside the scope: there was no agreement to pay, no obligation on anyone to give anything, and no reciprocal performance linking a particular payment to a particular service. People gave because they wanted to, not because they were buying a performance.

That is the test in miniature. Ask whether there is a legal relationship under which each party gives and receives something, and whether the payment is the actual counter-value for what the payer gets. If the answer is no, you are outside the scope.

What Makes a Donation a Donation

A genuine donation is freely given, and the donor receives nothing of substance in return. In practice, HMRC will look for all of the following:

• The donor is under no obligation to pay, and no obligation arises from paying
• The donor receives nothing in return, or nothing beyond a trivial acknowledgement
• The amount is set by the donor, not by a price list or tariff
• Any goods or services the charity provides are available on the same terms to those who do not donate

Bare acknowledgement does not create a supply. Naming a donor in an annual report, listing supporters on a plaque, or thanking a benefactor from a stage does not turn a donation into consideration, provided the acknowledgement carries no promotional message and confers no commercial advantage.

The moment the donor receives something with real value — advertising, hospitality, preferential access, use of your logo in their own marketing — the analysis changes.

Sponsorship Is Not a Donation

Where a business pays and receives publicity in return, that is sponsorship: a taxable supply of advertising services, standard-rated in the ordinary way. The distinction is not about who pays or how the arrangement is described in the agreement. It is about what the payer gets.

Arrangements frequently contain both elements. A company pays £25,000; in return its logo appears on event materials, it receives a table at the dinner, and the balance is a straightforward gift. Apportionment between the sponsorship element and the donation element is possible, but only where the donation is genuinely severable — that is, the donor would still have given that part had the benefits not been provided. A single undifferentiated payment for a package of benefits is consideration in full.

Get the apportionment documented at the time. Reconstructing it years later, against an HMRC officer with the sponsorship agreement in front of them, is a much harder exercise.

Grants: The Label Decides Nothing

“Grant” is a funding term, not a VAT term. Funders use it for genuine philanthropy and for tightly specified service procurement alike, and the same word in two agreements can carry entirely different VAT consequences.

The question remains the same: does the funder receive anything in return for the money? That includes anything supplied to a third party at the funder’s direction — if a local authority pays you to deliver a service to its residents which it would otherwise have to provide itself, the authority is receiving something, even though the residents are the ones who benefit.

Indicators That Point to a Supply

• The funder specifies detailed deliverables or outputs it requires, rather than general objectives
• Payment is linked to volumes — per beneficiary, per session, per unit delivered
• The funder receives reports, data, intellectual property, or research results it can use
• The funder is discharging a duty of its own, or procuring something it would otherwise buy
• The award followed a competitive tender or procurement exercise
• The agreement reads like a contract for services, with service levels and remedies for non-performance

Indicators That Point to a Genuine Grant

• The funder’s purpose is to further your charitable objects generally, not to obtain something
• The funder receives no benefit, and is largely indifferent to which individuals benefit
• Conditions exist only to ensure the money is properly applied, not to specify a service
• Clawback is triggered by misuse or by funds being unspent, not by failure to deliver a specified output
• Reporting is stewardship reporting — showing the money was spent as intended — rather than delivery of something the funder wanted

Conditions attached to funding do not, by themselves, create a supply. Almost every funder imposes conditions. The question is whether those conditions define a service the funder is buying, or simply protect the funder’s money.

The Business and Non-Business Test

Establishing that there is no supply for consideration is only the first stage. Even where money does change hands for something, the activity must also amount to an economic activity before it falls within the scope of VAT.

The framework now applied is the two-stage test drawn from Wakefield College v HMRC [2018] EWCA Civ 952:

• Stage one — is there a supply of goods or services for consideration, giving rise to a direct link between what is provided and what is paid?
• Stage two — if so, is that supply made for the purpose of obtaining income on a continuing basis, so as to constitute an economic activity?

HMRC confirmed this as its settled approach in Revenue and Customs Brief 10 (2022), withdrawing the older multi-factor “business test” that had been applied for decades. The practical significance for charities is considerable: subsidised provision, where fees are set well below cost and bear no real relationship to the value of what is provided, will often fail stage two and be non-business even though money changes hands. That was the position in Wakefield College itself, and in Gemeente Borsele (Case C-520/14) concerning subsidised school transport.

The Real Cost Sits on the Input Tax Side

Charities often welcome the conclusion that income is outside the scope, because no output tax is due. That relief is usually misplaced. Non-business income carries a direct and often larger cost: input tax attributable to non-business activity is not recoverable at all.

Where a charity has a mix of business and non-business activity, VAT on costs must be dealt with in two stages, in this order:

• First, a business/non-business apportionment removes the proportion of input tax attributable to non-business activity. That element is simply lost.
• Second, the remaining business input tax goes through the partial exemption calculation, which strips out the element attributable to exempt supplies.

Getting the order wrong, or collapsing the two into a single calculation, is one of the most common errors we see on charity VAT returns. It almost always produces the wrong answer, and because both calculations feed the annual adjustment, the error repeats every year until someone unpicks it.

There is no statutory method for business/non-business apportionment. Any method must be fair and reasonable, and you should be able to explain why it reflects the actual use of the costs. Income-based splits are common and often defensible, but they are not automatically appropriate — particularly where grant income is large relative to the activity it funds.

Research Funding

Research funding deserves separate thought. Where a funder commissions research and receives the results, that is generally a supply. Where a funder makes an award to advance knowledge in a field, takes nothing back, and the results are published openly, the funding is more likely to be outside the scope.

Collaborative research adds a further layer, because the flow of money between institutions may or may not represent supplies between them. Consortium arrangements need to be read carefully rather than assumed to follow the lead institution’s treatment.

Getting It Wrong in Either Direction

If income treated as a grant is in fact consideration for a taxable supply, the charity has under-declared output tax. Because the amounts received are treated as VAT-inclusive, the liability is one sixth of everything received, plus interest, plus a penalty determined by whether HMRC regards the error as careless or deliberate. Over a four-year assessment window on a recurring funding stream, this becomes a material sum quickly.

The reverse error is less visible but still costly. Charging VAT on genuinely non-business grant income means the charity has probably also recovered input tax it was never entitled to, understated its non-business restriction, and mis-stated several years of annual adjustments.

A Practical Checklist

• Read the agreement, not the covering letter or the internal budget line — the terms determine the treatment
• Ask what the funder actually receives, including anything delivered to third parties at the funder’s direction
• Distinguish conditions that protect the money from conditions that specify a service
• Where a payment is part sponsorship and part gift, apportion it at the outset and record the basis
• Apply the two-stage test: supply for consideration first, economic activity second
• Check that business/non-business apportionment is being done before partial exemption, not instead of it
• Review new funding streams as they are signed, not at the year end — the treatment is far easier to fix before the first receipt
• Keep the reasoning on file, so the position can be defended without reconstructing it years later

Grant and donation income sits at the point where funding agreements, charity law and VAT all meet, and it rarely yields to a quick answer. Where the sums are significant or the funder’s requirements are detailed, it is worth establishing the position in writing before the money starts arriving. Our wider work in this area is set out in our charity and non-profit VAT services.