VAT for charities: partial exemption, business vs non-business, and the new donation relief

There's a persistent myth that charities don't have to think about VAT. The reality is closer to the opposite: charities sit at the intersection of three of VAT's hardest concepts at once — exempt income, non-business activity, and partial exemption — and the organisations that get caught out are usually the ones who assumed none of it applied.

Three different "not standard-rated"s

The first trap is that "income we don't charge VAT on" hides three very different things:

• Non-business income: genuine donations, much voluntary fundraising, and grants that are freely given with nothing expected in return. This sits outside VAT. But not every payment labelled a grant is non-business (see below).
• Exempt income — certain education, welfare, some fundraising events. This is inside VAT but exempt, and it's what drags a charity into partial exemption.
• Taxable income — a shop, a café, room hire, paid services. Standard or reduced or zero-rated, but taxable.

When a "grant" is not a grant

Not every payment labelled a grant is outside VAT. HMRC looks for a direct link between the money and a supply: is the funder, or a third party the funder nominates, getting a specific service in return? If it is, the grant is consideration for a supply, and the charity may have to charge VAT on it.

The example that catches people out is Keeping Newcastle Warm. A charity was paid a fixed amount for each energy survey it gave householders under a government scheme. Because the money was paid per unit of output, it counted as consideration for a supply rather than a freely given grant, and it was taxable. Funding paid per result delivered is the strongest sign you have crossed the line.

The sting works on both sides. If a grant agreement says nothing about VAT, HMRC treat the figure as VAT-inclusive. On a £100,000 "grant" that turns out to be taxable, the charity hands over £16,667, that one sixth again, and keeps only £83,333 for the work. The funder can then be asked for a further £20,000 to cover VAT it never budgeted for.

So before you treat funding as outside VAT, look at what the funder gets for its money. If it is buying a service, from the charity or for someone else, it may be a contract in a grant's clothing.

The reason it matters: the VAT you incur on costs is only recoverable to the extent it relates to taxable business activity. Costs tied to exempt income feed the partial-exemption calculation; costs tied to non-business activity aren't recoverable as input tax at all and need a business/non-business apportionment first.

A charity with a grant-funded service, an exempt training arm and a taxable shop has to split its costs twice — non-business from business, then exempt from taxable — before it knows what it can reclaim. Miss a step and the reclaim is wrong.

If you've read our de minimis guide, the partial-exemption half of this will be familiar: the de minimis limits can still let a charity recover its exempt-related input tax in full, if the amounts are small enough.

The new donation relief

One genuinely helpful recent change: from 1 April 2026, a VAT relief applies to business donations of goods to charities. Broadly, a VAT-registered business can donate goods to a UK charity — for the charity to use, or to sell on for its purposes — without the donation triggering a VAT charge that previously made giving stock away costly. As with any relief there are conditions and records to keep, so check the current HMRC guidance for the detail before relying on it.

Where OneSixth comes in

Charity VAT is exactly the kind of multi-layered calculation that generic software ignores and spreadsheets get wrong under pressure. OneSixth runs the partial-exemption calculation — including the de minimis tests and the annual adjustment — and posts the result to your ledger with the workings attached, so the recoverable figure is defensible rather than estimated.