Colin Laidlaw revisits an issue of concern to independent schools with a new perspective on VAT on fees

Education is currently not subject to VAT when provided by certain types of providers (eligible bodies) and when charged for. The Labour Party recently confirmed it would seek to add VAT to independent education fees if elected to government in the next general election, following its promise to look at the tax position of independent schools in its 2019 manifesto: “We will close the tax loopholes enjoyed by elite independent schools and use that money to improve the lives of all children, and we will ask the Social Justice Commission to advise on integrating independent schools and creating a comprehensive education system.”

In a recent report the Institute for Fiscal Studies (IFS) estimated that adding VAT (at the current rate of 20%) to independent school fees could raise about £1.6 billion a year, resulting in an effective VAT rate, after allowing for deductions, of 15%. Although there are many variables on the effect of adding VAT to school fees, the IFS estimates there would be limited additional burden on the state as a result with net gain to public finances of up to £1.5 billion. To be fair to the Labour Party, this isn’t bad for a revenue-generating proposition.

However, whatever your politics and ignoring the “Will they get into power?” question, it’s clear that adding VAT will affect the sector. So, what do we know and what can we do about it?

Can Labour actually make fees subject to VAT?

The simple answer is yes. The current VAT rules are largely derived from a centralised set of EU rules or guiding principles which exempted the supply of education by certain bodies. Now the UK has left the EU, it is at liberty to change the rules as it wishes. A change in law would normally be announced in a Budget and enacted under Royal Assent, which could be relatively quickly after an election result.

The expectation is that the definition of an ‘eligible body’ would be changed but, the current rules are quite wide reaching and careful drafting will need to be carried out to ensure that any changes only affect those the Labour Party is targeting and not any or all education providers. While state education is free and therefore not subject to the VAT rules per se, a lot of paid-for education is undertaken outside the independent school structure and these would need to be separated.

In addition, there has been speculation regarding particular types of schools and whether they might be excluded from the VAT changes, such as special educational needs schools. The IFS reports that approximately 4% of pupils in independent schools have a statement of special educational needs for which funding is paid by the local authority, which would just increase the funding burden. Again, if this is the desired outcome, careful drafting would need to be carried out.

What can schools do?

The reality is that the options are limited. The point at which VAT is payable is based on the tax point and if a tax point can be advanced such that it occurs before the date of imposition of any VAT change date, in theory, no VAT is due; it remains exempt even if the services are provided much later on.

An advanced payment scheme would therefore enable fees to be charged in advance for the provision of future services (education) without VAT, but the fees would need to be paid (as payment creates the tax point) and available to the school to use as it wishes and not held under some form of escrow account or similar. Subject to any terms and conditions drawn up, this may expose the school to future loss and, in practical terms, it may just not be feasible for parents to stump up large amounts of fees in advance.

There has been a lot of reporting on this issue recently and any government taking note can take action to prevent such a scheme from having effect using anti-forestalling measures. Of course, these cannot be enacted if Labour is not in power, so anything carried out in advance of any change in law could potentially work.

In addition to anti-forestalling measures, HMRC can cry foul under the abuse provisions. Implementation of any scheme designed to avoid VAT will always be subject to scrutiny from HMRC and possible challenge. The devil is always in the detail and implementation is key and specialist advice should be sought in all cases.

What would be covered by a change in VAT?

First, will the rate be 20%? This is currently the standard rate of VAT in the UK and it’s likely that this will be applied here – in theory any government can use the reduced rate (currently 5%) or indeed, add an additional rate of its choosing (as happened recently during the pandemic for catering – 5% and 12.5% over differing periods). But anything less than the standard rate would appear to defeat the object of a revenue raising exercise.

Of course, the standard rate can also go up although, in the same manifesto, the Labour Party confirmed that it would “guarantee no increase in VAT” as “VAT is a regressive tax that hits the poorest hardest”.

Second, there is a general assumption that VAT will be added to school fees, but there are other fees charged by an independent school including catering, boarding, transport, sports and trips, alongside other income streams, not necessarily connected with the provision of education to fee-paying pupils.

Will these also be subject to VAT? Some of these would already be subject to VAT if supplied in their own right but are currently exempted where they are considered as ancillary to the supply of the education. Similarly, some of these might be exempt (for example, accommodation) or zero rated (for example, transport) if supplied separately. There are also special rules for supplies of trips which may kick in. It’s not straightforward and given the objectives, it seems likely that these extra fees would equally be subject to VAT.

In addition, a large proportion of independent schools offer some form of subsidised fees whether covered by a bursary or scholarship (or just reduced). The VAT implications of these would need to be considered – depending on circumstances, there may be hidden liabilities. Also, free supplies are generally considered to be non-business activities which may have an impact on VAT recovery, in certain circumstances.

Are there any advantages to charging VAT?

Yes, but the advantages are heavily outweighed by the disadvantages. The IFS concluded that the effective tax rate on schools would be around 15% (assuming a 20% standard VAT rate). This is because a business that charges VAT is entitled to recover VAT it incurs in carrying out its business. VAT exempt supplies do not allow VAT recovery and, at present, many independent schools are not registered for VAT.

This VAT recovery will depend on the VAT position of the income as discussed above:

• If everything is subject to VAT, all VAT incurred will be able to be recovered.
• If there remains an element of exempt activity, whether education or otherwise, not all VAT will be recoverable and some form of apportionment might be required.
• If there has been an advanced fee scheme in place this is likely to affect future recovery as costs are being used to undertake activities that are still exempt.
• There may also be an opportunity to recover VAT incurred on certain capital spend in the past 10 years if subsequently used for taxable activity.

This will vary significantly by school and advice should be sought as to how this might be achieved and, of course, the biggest cost for any school is staffing costs and these don’t have VAT on them.

Other things will also change. Schools will have to register for VAT and compete and submit VAT returns. It is likely VAT inspections will follow. It will be necessary to record VAT as a separate item – currently most costs are posted gross to the expense code – if VAT is to be claimed, it needs to be recorded. Finally, finance systems may need to be upgraded to take account of this and digitalisation rules (making tax digital).

Conclusion

There are a few ‘ifs’ and ‘buts’ not least whether the Labour Party will actually get into power, but it’s clear that if it does and it changes the VAT rules in respect of the supply of education by an independent school it will have a significant impact.

We have only touched on the VAT aspects and there are other areas which will be affected, and, for some schools, this may just be the straw that breaks them.

There’s not a lot that can be done to avoid the pain but forewarned is forearmed – you should model the impact of imposition of VAT and, if necessary, start having conversations with parents. Implementation of an advanced fee scheme may help in the short term but is unlikely to be a long-term plan.

Colin Laidlaw is a VAT director at accountancy firm Kreston Reeves.

Colin Laidlaw