Robert Warne reviews events in the months that have passed since VAT was introduced on independent school fees

There was substantial criticism within the education sector and among professional bodies regarding the lead-in time for a change in VAT law of this magnitude. Many felt that the six-month window was simply not long enough. This has since been borne out, with several issues still requiring clarification by HMRC, along with HMRC having to make changes to its own internal guidance well after the introduction of VAT from 1 January this year.

For many schools, applying for their VAT registration was the first obstacle to overcome – particularly when determining the correct effective date of VAT registration. This depended on their level of turnover, both historically and taking the date of the law change into account. HMRC did open a different department to deal with these applications. Generally, these new registrations went quite smoothly, although problems were encountered with schools attempting to group register with their trading company – especially where their trading company was already registered. These applications tended to suffer the most delay as old numbers were deregistered and new VAT numbers were ascribed.

For many schools that have registered for VAT for the first time, changing systems to identify and capture VAT on the purchases has been laborious enough. However, this has been compounded by also needing to ensure that the software systems in place are compliant with Making Tax Digital.

Having registered from what they believed to be the correct date, many schools then had their VAT periods which didn’t correspond with their financial year-end. This has led to a number of schools having to go back to HMRC to request changes to their VAT periods in order to align them with their financial year-end. However, what a lot of schools have failed to realise is that a VAT year-end does not automatically align with their accounting financial year-end.

The VAT year for HMRC automatically ends in March, April or May, unless the taxpayer notifies HMRC in writing of their preference for a different VAT year-end. Normally, a school would like its VAT year to be co-terminus with its financial year-end which generally ends in July or August.

If the school has not notified HMRC to have a special year-end for partial exemption, then it reverts to the standard year-end of either March, April or May – whichever ties in with its appropriate VAT period. Schools which haven’t notified HMRC and assumed it automatically ties in with their year-end may face problems in the future. The partial exemption year-end exercise could be completed at the wrong time, with the wrong information, with the wrong VAT periods included, leading to incorrect annual and capital goods scheme (CGS) adjustments. HMRC inspectors will not only adjust these calculations to the correct VAT year-end, but any differences will be subject to interest charges as well as possible penalties. Therefore, schools should check what they have done to ensure they have the desired VAT year-end.

Schools also faced difficulty with regards to clarifying what could be claimed back as input tax before they registered for VAT. Normally, where any entity has made exempt supplies (that is, education) before it registers for VAT, then no VAT can be recovered as HMRC views this VAT as having been being consumed in the making of exempt supplies.

However, HMRC changed its position a number of times on how the school sector should treat this pre-registration input tax, eventually introducing some concessionary treatment. For goods, schools were entitled to go back four years from the date of registration and identify the VAT incurred. Schools were then able to apportion this VAT over a 60-month period to calculate a recoverable proportion based on the number of months remaining in the 60-month period after the date of registration had been established. So, if for example a school purchased furniture 12 months before it registered for VAT, it would be entitled to recover 4/5th of this VAT, subject to any partial exemption calculation.

For services, HMRC altered its guidance as late as 2 June on this matter. Previously, HMRC had ruled that services were not recoverable where they had been consumed, or partly consumed, before the date of registration. However, HMRC has now accepted that services can be apportioned as well. For services, schools can go back six months from the date of registration and, again, can apportion the VAT to reflect the taxable use of the service after the date of VAT registration. Unlike goods, for services the time frame for the apportionment is 12 months. So, if a school purchased a 12-month software licence three months before the date of registration it can now recover 9/12th of the VAT, subject to any partial exemption calculation.

Although this is good news for schools which have registered for VAT as a result of the VAT law change, these concessions cannot be applied by any schools which have not had to register for VAT as a result of the VAT changes on 1 January 2025. This could bring into question the process of fiscal neutrality with regards to treating all taxpayers in the same way. It will be a significant cost to schools that were already VAT registered, which purchased goods over the last four years on which the VAT recovery is likely to have been negligible.

The change of law has also brought a number of schools an unwelcome surprise in respect of having to make payments on account – something most schools had not built into their budget at the outset. With three terms of fees being invoiced, and four VAT returns to be completed, it is likely that there will be three VAT returns with large payments, with the fourth return potentially being a repayment.

A ‘payment on account’ is automatically generated by HMRC where the school’s annual net VAT due exceeds £2.3 million and many schools will trigger this limit. For a number of schools invoicing and paying over the first terms fees since the change in law this threshold has already been exceeded. Once part of the HMRC direct Payments of Account (POA) scheme, schools are required to make monthly payments on account based on their expected VAT yield in a year with a balancing payment each VAT quarter when the VAT return is completed. In addition, those on the POA scheme are not entitled to the seven-day extension afforded to other taxpayers with regards to the submission and payment of a quarterly VAT return. An alternative to POA is to complete monthly VAT returns, but often schools will not want the extra administration.

As mentioned at the start this article, schools continue to be in correspondence with HMRC and a few issues remain that are yet to be clarified six months after VAT law was introduced.

A couple of the more significant areas are:

1. Third party grants – HMRC has insisted that, where a child is named in a grant/donation which is paid to a school as part of the school fee, then this money constitutes consideration for a taxable supply of education. However, there are a number of foundations and charities which operate a system whereby they provide financial assistance to many underprivileged pupils to attend private schools. These foundations get nothing back from the school and are not engaged in any legal contract with the school to provide services for a consideration (unlike a parent who would sign a contact with a school guaranteeing payment on the school fees for the service provided). They are also not in a position to enforce anything on the school or the pupil. This position is presently still being reviewed by HMRC policy, but it is creating uncertainty within the school sector, and significant sums of money are paid to the school by these foundations, trusts and charities to fund many deserving cases.

2. The standard method override (SMO) – HMRC has already undertaken a number of VAT inspections of schools and, despite the policy documents they issued at the outset of this change, there does not appear to have been any challenge to the fees in advance (FIA) schemes offered by schools where the appropriate documentation is attached to it. What will be interesting is whether they seek to enforce the SMO on schools – especially where they have benefited from applying the exemption to their school fees received before the cut-off date in July 2024. Most of the professional industry does expect them to apply this SMO as the law states the word “use” of the input tax in respect of the SMO calculation.

Professional advice should be sought on the SMO but, clearly for pupils who have benefited from FIA schemes, they are still “using” the VAT schools have incurred after 1 January 2025 to receive an exempt supply of education.

It would be expected that this would be a legitimate vehicle by which HMRC would look to clawback some of the VAT it has perceived to have lost under FIA. The SMO applies when there is a significant difference between what the school has recovered as input tax based upon the standard method of partial exemption and what it should have been recovered when the ‘use’ test is applied.

If this VAT difference is more than £50,000 when the annual adjustment and SMO is completed, and compared in respect of the residual input tax and the CGS adjustment, then a repayment to HMRC may be due.

With the significant sums of VAT involved, this could well be a legal battleground that won’t be resolved for some time if a challenge is made on its application either by HMRC or a school. It would be prudent for schools to consider the SMO in more detail when completing their annual adjustments while the FIA has an impact on schools providing education to their pupils which remain exempt from VAT. It does not appear equitable that schools can still apply the exemption to certain fees after 1 January 2025 under FIA, yet recovery input tax ignoring these exempt supplies. Obviously, in most cases, the SMO will only affect the next couple of years, as once the FIA schemes expire on the exemption side, the vast majority of schools’ income will become taxable.

We have already mentioned the capital goods scheme above, and all schools will have to complete this calculation as part of their annual adjustment. Recently it has been announced that the threshold for this will be increasing to £600,000 but, retrospectively, schools will be looking at identifying all qualifying projects over £250,000. Identification should not be the issue. It is ensuring that the correct date is used in respect of “completion” or “first use” and then, once that date is established, accurately determining the number of years remaining within the 10-year period.

This is especially important for schools that have not previously been registered for VAT, as they will need to calculate those pre-VAT registration years. For schools that were already registered, the focus will be on adjusting the recovery to reflect the significant increase in their taxable use for the capital good item.

So, there is much for schools to ponder, with work required over the next few months in respect of their annual adjustment and their capital goods scheme to ensure the recovery of VAT incurred is maximised. There will also be continual dialogue with HMRC on a number of specific areas that remain unclear, and it is expected that there will be an increase in VAT inspections by HMRC over the next 12 months as VAT returns are submitted with significant input tax claims.

Robert Warne is a partner and head of VAT at accountancy firm Crowe UK

Robert Warne