Warning for Not for Profits as HMRC makes changes to criteria of ‘what is a business activity’

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HMRC has changed how it now approaches determining whether or not an activity is a business activity. HMRC has also updated its VAT Business/Non-Business staff internal manual.

The changes are particularly relevant for:

• Charities
• Not for profits
• Providers of nursery and crèche facilities
• Businesses that receive grants or subsidies
• Organisations or businesses carrying out non-business activities

The changes feature in a new policy paper from HMRC, ‘Revenue & Customs Brief 10 (2022)’ and confirm a significant departure from HMRC’s longstanding policy of the last 40 years of applying the principles laid down in the cases of Lord Fisher [1981] STC 238 and Morrison’s Academy Boarding Houses Association [1978] in deciding whether an activity is a business or non-business activity for VAT purposes.

HMRC’s approach moves away from the 6 criteria that emerged from the above cases, known as the ‘business test’, being replaced by a new two-stage test.

Old ‘Business’ Test:

• is the activity a serious undertaking earnestly pursued
• is the activity an occupation or function that is actively pursued with reasonable or recognisable continuity
• does the activity have a certain measure of substance in terms of the quarterly or annual value of taxable supplies made
• is the activity conducted in a regular manner and on sound and recognised business principles
• is the activity predominately concerned with the making of taxable supplies for a consideration
• are the taxable supplies that are being made of a kind which, subject to differences of detail, are commonly made by those who seek to profit from them.

New 2-stage test:

• Stage 1: The activity results in a supply of goods or services for consideration
• Stage 2: The supply is made for the purpose of obtaining income therefrom (remuneration)

HMRC confirm in the brief that businesses can no longer rely on the old ‘business test’ to decide whether an activity is business or not and the 2-stage test is the approach that should be taken in determining whether an activity constitutes a business activity.

The old ‘business’ test can still be used as a set of tools designed to help identify those factors which should be considered.

Will the new 2-stage test be retrospectively applied?

Whilst updated guidance is welcome, particularly clarity on the requirement to consider individual activities not an organisation’s overall objective or profit motive, unfortunately, HMRC does not explicitly state whether this change in policy is to be retrospectively applied or from the date of the brief.  This lack of clarity is particularly problematic where for instance the previous ‘business’ test was used for securing zero-rating on large capital projects, opening up the potential for costly retrospective ‘clawback’. 

What is meant by ‘obtaining income therefrom (remuneration)’?

Additionally, and crucially, the new 2-stage test set, rather than put the matter to bed provides alternative uncertainty, with the elephant in the room being what is meant by ‘obtaining income therefrom (remuneration)’. The concept of ‘remuneration’ is not a statutorily defined term and nor has HMRC provided clarity in the recent changes.

It remains to be seen how HMRC and the courts will actually interpret ‘remuneration’. Until we have clarity this also leads to a potential evaluation of a chicken and egg scenario i.e. objectively is the activity being undertaken for the purpose of obtaining remuneration or does the fact that remuneration is received means an activity can be undertaken?

There is now significant uncertainty for many businesses and organisations that have non-business activities. Providers of nursery and crèche facilities appear to be most immediately at risk of HMRC as these are specifically referenced in the new guidance.

What can businesses and organisations do?

Businesses and organisations with non-business activities need to review the potential impact of the change in HMRC policy on an activity by activity level, especially where reliance has been placed on the old ‘business test’ e.g. the organisation’s overall objective or non-profit motive to determine non-business income.

When it comes to determining how a business activity should be treated with regards to VAT we would always advise you speak to a VAT adviser.