Charity Workshop newsletter | September 2023

At the end of April 2023, the Charity Commission updated CC8, the guidance that relates to internal financial controls for charities. It is now more concise and covers areas that have become more prominent since the original version.

First published in 2012 these updates will no doubt be welcomed with open arms and are long overdue.

What has changed?

One of the most significant changes is the internal controls checklist which provides a comprehensive list that shows you where there might be potential gaps in your own financial controls. It is a very thorough starting point and can be used to compare how your charity’s financial controls compare to the guidance – you should aim to complete it annually.

What the checklist does not do, is assess the quality of the controls. For example, there is a checkbox that asks whether your charity conducts regular bank reconciliations. However, it does not include the thoroughness, accuracy, timeliness, or quality of those reconciliations. The quality and effectiveness of your internal financial controls could be the difference between the prevention of fraud or error, and the failure to prevent fraud and error. So, while the checklist is a very good starting point, it should be accompanied by an assessment of the quality and effectiveness of those controls, not simply whether or not those controls exist.

It should be completed by a member of staff responsible for finance processes and reviewed at board level. Not all the controls on the checklist are relevant for all charities, and the systems and processes operated by larger charities will typically go significantly over and above the processes set out on the checklist.

The guidance sets out the risks associated with cryptocurrencies and emphasises the importance for charities to understand those risks before accepting cryptoasset donations. If this type of donation is accepted, there is a range of recommendations including having a policy in place on the acceptance of cryptoassets, the need to ensure that any platform used is compliant with UK regulations, the requirement to keep accurate records of donations, and the importance of following HMRC guidance around the taxation of cryptoassets.

Cybercrime continues to be a current threat and charities are often seen as a soft target. This section has some basic tips and then links to more in-depth guidance which covers everything from protecting your charity, how to report fraud or cybercrime, through to a cyber security toolkit for charity boards and what to do if you are experiencing a live cyber attack. Typically, charity boards tend to be relatively hands-off when it comes to dealing with cyber security and so the toolkit is especially useful. It provides a comprehensive range of best practice policies and templates as well as e-learning videos and a list of counter fraud questions that trustees should ask of their organisation.

Other areas which have become relevant since CC8 was first published and are now a focus area for the Charity Commission, include the use of mobile payment systems (e.g., Google Pay or Apple Pay), a refresh on advice for more traditional fundraising risks and holding collections, making payments to related parties, and operating internationally.

What should you do?

CC8 is a very useful and broad starting point for improving your financial controls and we recommend that all nonprofit finance teams read it and complete the checklist. It is an excellent tool for identifying financial control gaps and you should always review the guidance if and when new issues arise.

Autumn can offer a good opportunity to clean up your VAT affairs in preparation for the second half of the year. Indeed, for the purposes of good governance, it is good practice to have regular reviews and a strategic overview of your charity’s VAT affairs, both to manage potential risk, and identify efficiencies and planning. The world is ever-changing, and this can have implications for all areas of the organisation, especially tax and VAT.

Starting from the basics

Charities often have complex VAT accounting, normally because they undertake activities that do not fit neatly within the fundamentals of a VAT system. VAT is a self-administered and simple turnover tax, which is applicable to taxable supplies made in the course of business. However, this is not usually the main activity or primary purpose of a charity. Hence, this is why charities and charitable activities do not sit comfortably within a VAT system.

Charities may undertake a range of activities that attract different VAT treatments, or be outside the scope of VAT. This can determine:

• whether there are any positive VAT liabilities to pay to HMRC;
• how VAT incurred on costs should be treated: fully recovered, partly recovered, or fully disallowed; and
• whether there is an opportunity to avoid paying VAT from the outset by utilising available reliefs and efficient structuring.

It is important to recognise the difference between non-business activities/income and VAT exempt business activities for VAT purposes. In principle, both can lead to VAT incurred on related costs not being recoverable, but they are covered by different rules. Generally, the approach to VAT recovery is a two-stage process unless the charity has agreed a Combined method with HMRC. That said, the fundamental test as to whether VAT incurred on costs is recoverable is: can it be shown as having a direct link with a taxable supply, or intended taxable supply, made in the course of business? Essentially, is it a cost component or cost of sale of a taxable supply?

Two-stage process

It is necessary to first carry out a business/non-business apportionment of VATable costs before moving on to partial exemption apportionment. The second step involves looking at the taxable and exempt supplies made, and then to calculate the impact of these on VAT recoveries.

Non-business restriction is not partial exemption, so is not covered by these particular VAT regulations.

Business/non-business apportionments have far less regulations and requirements, with the key objective being to give a fair and reasonable VAT recovery. That said, the overall impact requires the same test to be applied; how are activities, be they non-business, business taxable or business exemption, consuming or using VATable costs?

It is worth remembering that certain non-business income can act as deficit funding, or passive income, and this means that it could be ignored when making a potential restriction in VAT recovery.

Partial exemption is covered by specific VAT regulations, and these dictate what method can be used to calculate recoverable VAT. The partial exemption regulations also require that an annual adjustment is carried out at the end of the VAT year, and this is for the purposes of smoothing out any potential seasonal fluctuations. The VAT year is usually the end of March, April or May, but it can be different if a partial exemption special method has been agreed.

The majority of partially exempt organisations use what is known as the default standard method, and this is based on a comparison of turnover figures. However, use of the standard method is not mandatory, and an organisation can apply to HMRC for use of a special method. Use of the standard method does not require approval by HMRC.

Any method needs to give a fair and reasonable recovery, and this needs to be based on the income and activities. The application for a partial exemption special method should be supported by indicative figures and example calculations. Any special method also has to be agreed with HMRC in advance and cannot be backdated.

Commonly used special methods include those based on staff numbers, floor space, purchases or transaction counts, or a combination of these or other methods.

When carrying out a review of your VAT affairs, it is always prudent to consider whether a change in method may be required or desirable. This could be because activities and income sources, or expenditure may have changed.

The VAT year end gives an opportunity for considering the following practical points:

• When was the overall basis for VAT recovery put into place?
• What activities were being carried out at that time, and what income was being received?
• What has changed (if applicable) since that time, e.g., new, or different income sources; the expenditure profile; significant capital expenditure, etc?
• Does the current VAT recovery method(s) provide for a fair, reasonable and realistic VAT recovery?
• Would a different method give a better outcome, and provide for a more accurate reflection of how costs are being used and consumed?

Conclusion and takeaways

VAT is a self-assessed tax, so the onus is on the taxpayers to both comply and maximise efficiencies. Charities and their VAT recovery is often regarded, as a complex area, so it is worthwhile to take a high level practical and pragmatic view. The objective is to keep up to date with your activities, income, and expenditure, and to accurately and effectively identify a method that reflects how VATable costs are used by the charity.

Very simply, the rhetorical question to ask is: “What am I buying, why am I buying it and what will I use it for?”