Is that a grant or a contract?

Their tax status is different, says Robert Nieri

In just over 20 years we have gone from Margaret Thatcher's denial that there is such a thing as society to David Cameron announcing that he wants a "big society".

The government wants to encourage local engagement and service provision by the third sector, but it is clear that money to go with that encouragement will be limited.

The charitable incorporated organisation, which may be well suited to helping communities get some projects off the ground, won't be with us until at least next year. Grant cuts next March are looming, but the Big Society Bank won't be lending money until November 2011.

So it's all about making the most of what you can get now. With that in mind, we need to ask what the difference is between grant funding and service contracts, why this matters and what you can do to maximise your legal position in respect of both.

It can sometimes seem unclear whether a payment of money subject to conditions and meeting key performance indicators is a grant or a payment for services. In essence, money paid to the recipient for work the funder wishes to sponsor but for which it doesn't receive direct benefit in return is a grant. Contrast that with a contract from which both parties seek something tangible: payment for services rendered, especially where the paying party is obliged by law to ensure those services are delivered.

Why does it matter? One reason is tax. Charities do not pay VAT on grants they receive. But if a charity is being paid to provide a service, it may be charged VAT. It also matters because of the possible application of the EU procurement regime, which relates to contracts for services but not to grants, and is implemented in the UK through the Public Contract Regulations 2006.

If the rules aren't followed - for example, if the relevant authority does not go through the process of publishing an advertisement and having competitive tenders submitted - then a contract could be challenged and be subject to a Declaration of Ineffectiveness, which means a signed deal could be made void by a court.

Even if the regulations don't apply, the award could still be challenged under EU treaty principles on the grounds of fair dealing and transparency. Traditionally, grants have been given to fund work designed and proposed by the organisation the funder wishes to sponsor.

Charities should not be afraid to be creative in the provision of services. Where appropriate they could seek to help design the procurement process of commissioning bodies to ensure the inclusion of socially meaningful outcomes, rather than waiting for the tender to arrive and then having to sign up to provide services in accordance with reams of stringent and sometimes meaningless outputs.

Look at the small print. If there are lots of requirements with which the recipient must comply and the language seems inappropriate for a grant (such as 'contractor', 'performance standards') but you still consider you're signing up to a grant, then do your best to have a new clause inserted. The clause should say that while the parties may consider VAT does not apply, if HM Revenue & Customs decides it does, the payment will be deemed exclusive of VAT so that VAT doesn't diminish the size of the grant. This may be acceptable to the grant funder, especially if it can recover VAT.

Devise a simple checklist for relevant staff to identify whether it's a contract or a grant, or at least to raise the question in their minds so they can seek advice where appropriate.

In either scenario, prepare a summary of the key terms and diarise your obligations. Especially in the current economic climate, both funders and commissioners will want to maximise the bang they get for their buck so you should minimise the risk of a grant claw-back or any claim for damages for breach of contract against you.

- Robert Nieri is senior associate at Freeth Cartwright

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