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MICHAEL HITCHEN and JUDITH D'AGUILAR LLB, of WJB Chiltern examine the implications of the High Court's decision in Commissioners of Customs and Excise v Yarburgh Children's Trust.

IT IS NOT known at this stage whether the Commissioners will appeal from the High Court decision on 29 November 2001 in the Yarburgh Children's Trust case. Careful reading of the judgment would indicate, however, that this is most likely as it has far-reaching consequences on Customs' current interpretation of their legislation, as we shall demonstrate.

The case relates to the liability of construction services provided to a charity, namely the Yarburgh Children's Trust. The VAT tribunal found for the trust on two counts, viz: that it was not engaged in business activities in relation to its letting of the property to another charity (a playgroup), and, secondly, that the property was used in a manner similar to that of a village hall. Customs appealed the decision to the High Court.

Significant decision

In dismissing Customs' appeal, the High Court's reasoning makes a significant revision of Customs' published view of economic activity in relation to the letting of property and also the application of section 94(2), VAT Act 1994 in relation to supplies made by unincorporated associations to its members.

The Court summarised the issues to be determined as follows.

• Was the lease an intended use of the building by the trust otherwise than in the course of furtherance of a business?
• Was the playgroup's use of the building otherwise than in the course of furtherance of a business?
• Did the intended use of this building by the trust and by the playgroup fall within the definition of relevant charitable purpose contained in note 6(b) to Group 5 of Schedule 8 to the VAT Act 1994 (the village hall provision)?

In relation to the use of the property by the trust, the Court considered the application of Article 4(2) of the Sixth Directive, which reads as follows.

'The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.'

The Court in finding for the trust suggested that the 'mere fact of letting at a rent is not sufficient in itself to render that transaction an economic or business activity'. It observed that it was 'relevant to consider the wider circumstances of the grant including the identity and nature of the parties before deciding whether it fell within Article 4(2)'. Furthermore it was the Court's opinion that it is the economic nature rather than the legal nature of the transaction that was at issue. On this point, the Court concluded that the tribunal was entitled to conclude that the lease granted to the playgroup, although at an annual rent, did not constitute the carrying out of an economic activity.

Analysis of economic activity

The Court then considered whether the playgroup, which was the occupier and user of the property under the terms of the lease, was also involved in an economic activity. Customs had appealed on this basis and made two points. The first and primary argument was that the playgroup operated as a business because it charged for its services.

The Court identified that the playgroup was a serious undertaking which was properly organised and with reasonable continuity. However, its main purpose was not predominately concerned with the making of taxable supplies for a consideration. It did not have the same objectives as that of a commercial playgroup run for the purpose of profit. Its aim in setting this level of charges on those persons attending was simply a means of balancing the overhead costs of the organisation with the perceived ability of the parents to pay. In balancing off the various points, the Court decided that the tribunal was entitled to conclude from the evidence before it, that no business user was involved.

This left the alternative argument put forward by Customs that the application of the provisions of section 94(2), VAT Act 1994 automatically caused the playgroup to be in business. Section 94(2) reads:

'Without prejudice to the generality of anything else in this Act, the following are deemed to be the carrying on of a business -

The Court determined from an examination of the playgroup's structure and previously decided cases that it was either an association or an organisation within the meaning of section 94(2). It then considered how section 94(2) should be interpreted in the light of Article 4 of the Sixth Directive.

The Court decided that section 94(2) does not require a supply of services which is not inherently commercial to be treated as such. That being so, the operation of the playgroup was not converted into an economic activity and the supply made to the parents could not be treated as a business activity for VAT purposes.

Finally the Court considered whether the use of the property by the trust or the playgroup fell within the definition of relevant charitable purpose contained in note 6(b) to Group 5.

The Court observed that note 6(b) was intended to preserve zero rating for village halls or other buildings used for a similar purpose. It was not enough to show that the building was intended to be used for an activity which could take place in a village hall and made available to members of a local community. What needs to be shown is that the building is, or fulfils the role of, a village hall or other building designed for public use in the provision of social or recreational facilities for the local community. Although in this case, the building's use is severely restricted by the application of the Children Act, this does not reach the criteria specified in the VAT Act where the building could be seen to be used in a manner similar to that of a village hall. This view may throw doubt on earlier decisions.

Far-reaching consequences

The difficulties for Customs which result from this decision can be summarised as follows.

Customs interpret the word 'business' widely, making the point in paragraph 7 of their notice 701/1/95 as an aid to assist charities to decide whether they are in business. This reads:

'The position is not affected if the amount charged for the supply does no more than cover the cost to the charity of making the supply; nor where the charge is less than cost.'

The Yarburgh judgment conflicts with this statement, and many charities may now find themselves in a position where previous applications for authority to issue a certificate for zero rating of a supply of property which were turned down by Customs could be unsound. These charities will need to review their position carefully to determine whether they should make a further application to Customs in respect of the zero rating of supplies which have been made to them, even if the decision was made more than three years ago.

The judgment also throws into considerable doubt the broad interpretation of section 94(2) in respect of clubs and associations. The interpretation set out in VAT leaflet 701/5/90 which sets out that the provision of membership benefits by any club, association or society is always to be treated as a business activity (excluding certain organisations and subscriptions) is now in doubt.

It may well be that clubs and associations which are currently treating their income as business for VAT purposes and have registered for VAT on this basis now need to consider whether certain parts of their income should be removed from their turnover and whether they should seek to apply for deregistration. It is possible that there has been an overpayment of VAT which would qualify for repayment.

Both charities and section 94(2) bodies should immediately review their respective VAT positions in the light of the judgment and take immediate action as necessary to protect their positions.

The Yarburgh case provides suitable opportunity for charities who have paid VAT in error in similar circumstances as above, or seeking to obtain zero rating of supplies that are of a comparable nature, to request a reconsideration regarding the treatment of supplies. A protective application must be made to secure the charity's position against the three-year limit for repayment of any tax. Such action needs to be taken irrespective of whether Customs might choose to appeal the decision to a higher Court.

Michael Hitchen and Judith d'Aguilar can be contacted on 020 7339 9000.

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