Grant or contract? Why does it matter?

Background

In September 2003 Woking Borough Council (Council) and Woking Museum and Arts and Crafts Centre (Centre), a registered charity, entered into an agreement whereby the Centre agreed to provide “arts museum and cultural services” and a visitor information service to the Council in return for an annual sum of £224,000 together with one-off payments.  A dispute arose with HM Revenue & Customs as to whether this arrangement was a grant or a contract.

If the arrangement was a contract, the Centre could charge VAT on the fee payable by the Council and recover the VAT incurred on its costs.  The Council in turn could recover the VAT charged by the Centre under the special provisions for local authorities in section 33 of the Value Added Tax Act 1994.  Alternatively, if the arrangement was a grant, the payment from the Council would fall outside the scope of VAT and the Centre would be unable to recover the VAT incurred on its costs.

In April 2004 HM Revenue & Customs ruled that these arrangements were a grant rather than a contract.  Nonetheless, the Centre did charge VAT and HMRC wrote to the Centre to reiterate its view that no VAT was chargeable.  The Centre appealed against that decision to the Tax Tribunal.  The Tribunal rejected HMRC’s argument that the payments were, in effect, grant funding and held that the services supplied by the Centre were contractual because:

• the parties had clearly intended the agreement to be contractual.  If the services had not been provided, the Council would have been entitled to sue for breach of contract.  The services provided by the Centre were explicitly described as being “in consideration of the annual payment”;
• the witness statements made by the Council and the Centre were credible and explained the reasons for the arrangements;
• the Centre was not obliged to do anything in particular with the sums provided by the Council (i.e. the payments were not held as restricted funds);
• the services provided a significant and direct benefit to the Council in giving effect to its policy objectives; and
• the arrangements were not non-commercial in nature.  The Tribunal explicitly noted that a transaction is not non-economic simply because it involves a charity pursuing its charitable objects.  There was reasonable evidence that the relationship between the Council and the Centre was on an arm’s length basis (even though the Centre was the only party interested in providing the services and so had a “special relationship” with the Council).

Commentary

This case is a useful reminder of the legal distinction between contracts and grants and the VAT implications.  For example:

• Grants fall outside the scope of VAT and the public procurement regulations.  Grants are generally unenforceable against the funder unless executed as a deed; and
• Contractual payments may be liable to VAT.  A public authority will need to comply with the public procurement regulations if the nature and value of the contract meets the relevant threshold.  Contracts will be enforceable by either party against the other.

Charities receiving funding to support its services should ensure that any agreement is properly drafted as a grant or contract, as intended by the parties, and should consider the relevant legal and VAT implications.

For more information please contact Chris Hook or 0191 211 7929.