Finance extra: Treasury's view on VAT campaign

Since the General Election, the Charities Tax Reform Group and the sector umbrella bodies have been pressing the Government to reform the complex and anomalous system of levying VAT on charities and voluntary organisations. Third Sector is supporting the campaign and recently asked the Treasury ten questions about VAT - all of these are printed here alongside the statement it issued as a response. You can find out what our view of the statement is by turning to page 22: please email your own views on its response to thirdsector@haynet.com.

1: The Labour election manifesto said the voluntary and community sector has shown itself to be innovative, efficient and effective, adding: "Its potential for service delivery should be considered on equal terms." What part does the Treasury plan to play in implementing this section of the manifesto?

2: Does the Treasury see any merit in the arguments of the Charities' Tax Reform Group that the VAT system treats charities unfairly and that they cannot compete on a level playing field with the private and public sectors?

3: If so, which aspects of the VAT system could be most easily reformed to make them fairer to charities?

4: Does the Treasury accept that 'section 33' relief, which allows local authorities providing care services to recover input VAT, means that charities providing and competing for similar services will remain at an unfair disadvantage unless similar relief is available to them too?

5: Ministers have claimed that tax relief on giving compensates charities for their irrecoverable VAT burden. But what of charities that get little or no donation money from the public and instead rely on grants from local authorities or grant-making trusts? They are penalised under the VAT system but do not benefit from initiatives such as Gift Aid.

6: In the last two budgets the Chancellor introduced VAT grant schemes to compensate churches for the VAT cost of repairs to buildings. Why can this concession not be extended to other charitable projects?

7: The CTRG says that whereas VAT amounts to 1.5 per cent of total expenditure for the private sector, the comparable figure for charities is 4 per cent and in the case of some charities is 10 per cent. Does the Treasury agree with these figures?

8: If so, does the Treasury think this state of affairs is defensible or equitable?

9: Estimates of the irrecoverable VAT paid by charities range from £500m to as high as £1bn. What is the Treasury's figure for this?

10: Do ministers intend to press the case in Europe for VAT reform for charities during Britain's current tenure of the EU presidency - and, if so, under what headings?

TREASURY STATEMENT

No Government has considered the issue of charities' irrecoverable VAT more seriously than this one. It has conducted two major reviews, which considered this issue carefully and explored the scope for targeted VAT refund schemes. However, the Government has been unable to find a solution that is practical, affordable, well-targeted and based on principle. Instead, the Government has concluded that available resources are better and most effectively deployed through targeted public spending and the existing tax reliefs, rather than a general refund scheme that would risk missing the target and failing to benefit those that the Government particularly wants to help.

The Treasury has spearheaded the development of the third sector's role in service delivery and in building stronger communities - leading the 2002 cross-cutting review of the role of the voluntary and community sector in public service delivery, publishing the findings of the 2004 VCS Review and responding to the recommendations of the Russell Commission on youth action and engagement. This has resulted in record targeted investment of more than £450m to develop the sector's capacity for service delivery and greater recognition within government of the role the sector can play.

The Government is working with funders to promote the principle that where third sector organisations engage in service delivery, contracts reflect the full price of delivering the service, including irrecoverable VAT costs. Although there are VAT reclaim arrangements for local authorities, this reflects the original commitment, made when the VAT system was introduced in 1973, that the tax would not fall as an added burden on local ratepayers. Clearly this rationale does not require that the refund scheme be extended to bodies - such as charities - that do not levy local taxation and, apart from the very limited number of bodies covered by section 33 of the VAT Act 1994, no public service delivery body - whether private or public - has an equivalent VAT refund scheme.

Charities enjoy a wide range of tax exemptions and special provisions. As well as the reliefs for charitable giving, most of the income and gains of charities are exempt from income tax, capital gains tax or corporation tax, and many charities benefit from mandatory business rates relief. The various reliefs and special provisions are worth around £2.5bn to the sector every year. This includes a number of VAT exemptions and zero rates that apply to charities, worth at least £200m. So the issue of irrecoverable VAT needs to be set against the broader range of support offered to the charity sector through the tax system and the various spending programmes.

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