January’s increase in the standard rate of VAT could represent a “commercial nightmare” for third-sector employers not registered for VAT, according to David Thornhill, managing director of Cash Simply.

Following the announcement in the June 2010 Budget that the rate of VAT will increase to 20% from 4 January 2011, campaigners the Charity Tax Group (CTG) estimated that the increase will cost the third sector an additional £140m.

Thornhill says: “With the introduction of the Conduct of Employment Agencies and Employment Businesses Regulations, which were followed by the removal of the Staff Hire Concession (which when used correctly meant that VAT did not have to be charged on temporary workers wages), employment businesses have to charge VAT on the wages of workers supplied.

“Of course, that is no big deal for VAT-registered businesses who simply claim back this element as part of the input tax on their VAT return. However, for the likes of charities not registered for VAT and therefore unable to claim back this cost on wages, it can be a commercial nightmare and next month it is only going to get worse for them.”

Thornhill says: “If the cost of a temp worker is 80% of the total net invoice value, then it follows that 80% of the unrecoverable VAT will be related to the workers’ wages, meaning that for every £100 of net invoice such charities will have to pay an extra £16 that they cannot recover.

“While charities cannot put themselves on a level playing field with businesses, which can claim the whole £20 VAT back as input tax, they can get close by saving £16 and return to the position they were in before the Staff Hire Concession was removed.

“It needs the right contracts but if the workers are engaged by the charity on a short-term hire contract and the payroll is outsourced to an independent payroll company that can also fund the wages, invoice them separately and become the PAYE agent for the charity, then as far as the charity is concerned, it is as simple as working with an employment business but the cost of unrecoverable VAT is removed from their total costs.

“With the recruitment business simply charging for its administration services (on which VAT must be charged), then £16 of unrecoverable tax that charities unregistered for VAT have to suffer for every £100 of net invoice for temporary workers can be legally avoided.”