The prepayment quandary  

  • 3rd October 2024

Matheu Smith offers advice on planning for HMRC challenges to prepayment arrangements 

 

The government’s proposals about how it intends to apply VAT to school fees explain that from 1 January next year all education services and vocational training supplied by private schools for a fee will be subject to VAT at 20%, as will related boarding services. This article concerns planning for the challenges that now seem likely to arise to prepayment or other arrangements used to try avoid the VAT.

Any fees paid from 29 July this year pertaining to the term starting in January next year onwards will be subject to VAT. Much initial commentary celebrated that this meant prepayment, or other arrangements used before then, would avoid the VAT, but the position is not so simple.

In the proposals, the government says it was aware of reports of an increase in the use of prepayment arrangements and it tacitly acknowledges that prepayment arrangements can avoid VAT imposed later. However, it believes that in many cases the arrangements will not be effective, stating: “The government is committed to tackling tax avoidance and in line with the principle to ensure that the changes are fair and that all users of private schools pay their fair share, HMRC will be carefully scrutinising the detail of these schemes to ensure that schools pay the correct VAT where it is due.”

 

Accordingly, in the next year or so, many schools will find themselves subject to some form of HMRC enquiry to check whether they have participated in any prepayment schemes, or other arrangements designed to avoid VAT imposed at a later date. Where a school has done so, the enquiry process may be lengthy and conclude with HMRC ruling that the school is liable to pay the disputed VAT.  A school might seek to pursue legal proceedings in the form of a statutory appeal, and it may eventually win. However, the process of going through an HMRC enquiry and then an appeal will be costly and slow. Furthermore, the default position is that the disputed VAT has to be paid as a precondition to pursuing an appeal.

Schools should begin to consider how they will act if subjected to scrutiny by HMRC, especially as short procedural deadlines can arise later.

Funding the cost

The question of how to meet the cost of any professional advice and representation needed may be fraught with difficulty.

Some schools will have insurance which will fund the cost of dealing with an HMRC enquiry, perhaps even a statutory appeal. Insurance policies should be checked – such cover can be a stand-alone policy or part of a much broader policy. Schools with such insurance should familiarise themselves with their obligations to notify potential claims. Often deadlines are short and attempting to deal with the matter before notifying the insurer can void the cover.

Schools without such insurance will have to consider the following issues. Assuming a school will seek to charge any VAT due to the parents who have prepaid the fees, it is those parents who will benefit if HMRC eventually accepts (or a tribunal decides) that no VAT is payable, rather than the school. Plainly parents who have not sought to avoid paying the VAT will be unhappy to see their school spend its resources on battling HMRC and disputes may arise over whether it is proper for a school to do so. In most cases the cost of dealing with an HMRC enquiry and any statutory appeal will not be recoverable from HMRC, even if it is eventually decided that no VAT is payable. If the costs will not or cannot be met by the school, it may face difficult conversations with parents who used prepayment or other arrangements about them funding the cost of dealing with an HMRC enquiry and any appeal, even if the school is ultimately successful in contesting that VAT is not due.

Some test cases may emerge alleviating the funding issues for others whose disputes are put on hold to await the outcome. However, even those left waiting will have to bear the cost of dealing with an HMRC enquiry and perhaps starting a formal appeal to maintain their right to contest whether the VAT is owed.

HMRC will be well aware of these funding challenges. Once a VAT assessment is raised, the school faces the burden of showing that HMRC’s view of the matter is wrong to win an appeal. A school may have a good case to argue, but if it is unable to fund the fight, HMRC will be content for the VAT assessment to stand.

Whether or not insurers are involved, a school should consider who it will turn to for professional advice and involve them in the discussions about how to fund any work that may need to be done.

Payment of disputed VAT

The default position is that disputed VAT must be paid as a precondition to pursuing an appeal. It is repaid (plus repayment interest) if the appeal is successful. Accordingly, schools will have to consider how to handle payment and possible repayment of the VAT. A school will have to get the parents that used the prepayment, or other arrangements, to pay the disputed VAT or pay it out of the school’s funds. Of course, not all parents may be able to fund payment of the VAT on the fees they have prepaid.

In some circumstances HMRC will agree to defer payment of the disputed VAT until the end of the appeal process, but if a school did that and later lost the appeal, it would have to pay the VAT and also late payment interest, which currently accrues at 7.5% per annum. Very significant amounts of interest can accrue in the course of disputes with HMRC.

Time

Complex HMRC enquiries often take more than a year to complete. It may then take a couple of years for a statutory appeal to conclude. Where test cases end up being pursued to the Court of Appeal or Supreme Court, it is not unusual for disputes to take more than five years to resolve. Accordingly, schools and parents may face years of uncertainty over whether VAT is due in respect of prepayment or other arrangements which they used. By the time any dispute is resolved the children of those who used the arrangements may have long since left the school.

It is hoped that one outcome of the consultation on how VAT should be applied will be greater clarity about the treatment of prepayment and other arrangements so that schools are not distracted from educating their pupils by battles with HMRC and/or parents. In the meantime, schools should plan for how to deal with HMRC enquiries and appeals.

Matheu Smith is a tax disputes specialist at Keystone Law

Matheu Smith

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