Navigating the 5%

Pulled in many directions

Last month, I suggested that HMRC’s perspective on whether a charity was engaged in business or non-business activities could be affected by whether the charity either:

  • Wanted zero-rating on a new building; or
  • Wanted to be VAT-registered on the basis that its public funding represented consideration for making a taxable supply.

Charities often find themselves torn, especially those involved in social enterprise. Many bodies funding the construction of new buildings will want to see that the charity is seeking to make its ownership of the building sustainable by bringing in other organisations, not necessarily charities, or charities that are engaged in “business” activities. From a funder’s point of view, such commercial use of a building is likely to help wean the charity away from handouts. From a VAT point of view, such use could either stymie the charity’s entitlement to issue a zero-rating certificate or expose it to the risk of a clawback of zero-rating at a later date.

Why 5% is relevant

To achieve zero-rating upfront, the charity must certify its intention to use the building solely for non-business purposes (unless relying on the relief for village halls and similar). In practice, “solely” means at least 95%. The clawback can occur at any time in the following ten years if business use grows to more than 5% of total use. The clawback then scoops up the whole of the business use, including the part covered by the 5% de minimis. So, if a charity that was sitting on 95.5% non-business use finds that decreases to 94%, it would face a charge based on 6%, not 1.5%.

What does 5% look like?

A charity approached me wanting to know how much business use it could allow without facing a clawback. I had to check that this did not reflect a long-standing intention to allow more than 5% business use. If it had, then it would have been exposed to a challenge from HMRC to the effect that its zero-rating certificate had been incorrect (see Greenisland Football Club for an example of HMRC taking such an action, albeit unsuccessfully). What had happened was significantly different. After the charity had completed its “state of the art” new building, it received approaches from other community bodies that wanted to use the facilities themselves when they were not being used by the charity.

What did we find?

Working together, we found that the opportunities were very limited. HMRC do not stipulate how the 5% should be measured, but require the methodology used to have the following characteristics:

  • It must be fair
  • It must be accurate
  • It must be straightforward to operate and for HMRC to audit.

They suggest, and give examples based upon, staff numbers, floor area, ongoing funding, time, and combinations of any of these.

For this particular client, the scope for further business use was very limited. The building was already used by a local non-charitable sports club on a reciprocal basis. Once this barter arrangement had been taken into account, the financial opportunity arising from any further business use was not proportionate to the resources that would have been needed to monitor the 5% threshold. In addition, the charity did not have the staff resources it would have needed to comply with its VAT liabilities if it had been required to register and account for VAT on the clawback.

Lessons for other charities?

The outlook may not be as bleak for other charities that want to combine commercial and non-business activities under one roof. There are often ways to mitigate or eliminate costs, especially if planning is undertaken early enough. For example, a zero-rated purchase of a building can sometimes be less problematic than zero-rated construction.

If you run a charity planning a new building, or advise one or more clients that are charities which are planning a new building, then please get in touch:


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To discuss how this may affect your clients or your business, or to talk about a VAT issue in general, please get in touch.
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