This article was originally published in April 2023 and was updated in November 2023.
The Labour Party has confirmed its intention to implement a policy (originally announced in its 2019 manifesto) to remove the exemption from VAT on independent school fees.
In this article we address some of the questions arising from that proposal. It is important to stress that, for the time being, with no detail on how the policy would be put into effect, it is too early to advise schools on the precise implications. Nonetheless, we look at some initial measures that can be considered, and which we are aware that many schools will already be looking at in detail.
Separately, although Labour appears to have reversed its plan to remove charitable status from independent schools (which would have prevented access to a range of tax reliefs), there remains an intention to withdraw relief from business rates. This issue is beyond the scope of this article, which is focused only on the removal of the exemption from VAT.
Why is VAT not currently payable?
Under VAT law in the UK, the provision of education by an “eligible body” (which includes a registered independent school) is an “exempt” supply for VAT purposes. Goods and services that are closely related to education are also exempt from VAT eg catering, transport, school trips and boarding accommodation.
In addition, there is a separate VAT exemption for a charity or not-for-profit entity which supplies education or vocational training if it:
- Cannot and does not distribute any profit (to use the terminology of the legislation) it makes, and
- Any profit that does arise from its supplies of education is used solely for the continuation or improvement of such supplies.
How soon could VAT be imposed?
Theoretically, a new Labour government could pass a law at a time of its own choosing to change the definition of “eligible body” to omit independent schools. This might be part of a new government’s budget, or it could be introduced independently of that. As the matter would relate to taxation (a so-called “money bill”) the House of Commons would have “financial privilege”, meaning that, provided certain conditions are met, the House of Lords would have no ability to oppose it.
How would a VAT charge affect the level of school fees?
Like any other business which makes VAT taxable supplies, if a school were obliged to charge VAT on the supplies it makes, it would in turn be able to set-off the amount of VAT which the school has itself paid on goods and services supplied to it and which have been incurred for the purposes of the business (for example utility bills, repairs and maintenance costs or professionals’ fees). In addition, the VAT charged on capital expenditure (eg on new buildings or other major projects), may also be recoverable, including on projects completed before the change in VAT status.
For these “VAT recovery” reasons, schools are unlikely to need to pass on a full 20 per cent increase in the overall cost to parents and should be able to reduce the VAT exclusive fee somewhat before the VAT charge is added (leading to an overall increase of, perhaps, 15 per cent rather than the full 20 per cent).
Would VAT need to be charged on the full amount of the school fees?
There has been some discussion among tax professionals as to whether the aggregated “supplies” made by schools could be separated out such that the new VAT charge would apply only to certain elements.
For example, the supply of after-school care by a school can qualify as “welfare services”, which are exempt under existing VAT law. Similarly, accommodation of the type provided to children who board at school would also, on its own, be treated as VAT-exempt, and transport services can be zero rated. Whether such a disaggregation would be possible will depend on what the new law says and what the legislators’ stated intentions are. At this stage this is impossible to predict.
That is not to say that schools should sit on their hands. Below, we suggest some preliminary steps that schools could consider taking so that they are prepared to act when the details of the policy, and the likelihood of it becoming law, are clearer.
Would schools need to change the terms of their terms and conditions/parent contract?
In general, unless stated otherwise, the amount payable for goods or services will be regarded as being inclusive of any VAT chargeable. Schools will therefore need to check their terms and conditions/parent contracts and, if necessary, include wording to permit the charging of VAT in addition to the stated fee.
The current version of the Independent Schools’ Bursars Association (ISBA) Model Parent Contract includes optional wording stating that the fees are exclusive of any taxes.
How would bursaries and discounted fee arrangements be affected?
To the extent a bursary is an agreement to provide education free of charge, no VAT can attach to that supply because nothing is “paid” in return for the service.
Similarly with discounted fee arrangements, VAT would only be chargeable on the discounted amount paid.
(This assumes the school in effect bears the cost of any discounted fees. Bursaries funded by third parties would be treated differently, in all likelihood with the full cost being VATable.)
Would VAT be charged to parents who are based overseas?
Yes. The general rule for supplies of services which are made by a business to a consumer is that the place of supply is where the supplier belongs, irrespective of the location of their customer.
Would VAT still be charged where the fees are settled by a third party, eg a grandparent or a trust?
Yes. The supply of education which is made to one person but paid for by another would still be treated as a supply to the actual recipient.
What about fees that are paid in advance?
The VAT “time of supply” rules are key to understanding this issue.
In most cases, VAT is due on a supply of services on the date the services are performed. The date can be brought forward if an invoice is issued or payment is received in advance, provided that at the time of making the payment or issuing the invoice, the services being paid for are precisely identified. However, where services are “continuous” in nature, tax is automatically due when a VAT invoice is issued or when payment received, whichever occurs first.
Which of these rules applies in this context is debatable. One may instinctively consider education to be a “continuous” activity, but it is evident that a school education has an end date (which will be either when the child completes their schooling or leaves to attend another school). Similarly, although a parent may not know at the outset precisely which subjects their child will be taught and by whom, they will know a great deal about the manner of education their child will receive, the duration of the education, and other key information about the school and its offering at the point at which they make an advance payment.
What is more certain is that whichever of the two time of supply rules applies, where fees have been paid “up front” and prior to a change in the law, in principle VAT would not be due on these sums paid. However, it is important to note that any new law imposing VAT may be made effective from the date the change is announced, rather than from the later date the law is actually passed (using so-called “anti-forestalling” legislation). Similarly, any government has wide discretion to pass taxation laws so could in theory legislate to change the rules on VAT and its interplay with fees in advance payments as it sees fit, or introduce legislation that has retrospective effect which would therefore apply to pre-existing lump sum payments.
We have recently advised the ISBA on an update to its guidance note and template terms and conditions for fees in advance schemes and produced a guidance note exploring these issues in more detail. Schools that are members of the ISBA can access these resources in the ISBA Reference Library.
Are there steps schools should take in light of the proposed changes?
The following are some immediate measures that schools could adopt:
- Review and, if necessary, amend their terms & conditions/parent contracts to ensure that the school has the contractual right to charge VAT in addition to the stated fees, should the law change.
- Undertake a preliminary accounting analysis to estimate what their net exposure to VAT would be (ie how much of the input VAT the school currently pays would be available for offset against the VAT that would become payable in relation to fees). Anecdotally, we understand that some schools are updating their accounting software to enable this analysis, particularly on input VAT.
- Prepare a breakdown of all of the components of the school fees to identify the cost associated with those elements that could, potentially, remain exempt from VAT or zero rated (eg accommodation, after-school care, transport). This is something on which specialist advice might be necessary.
- Consider deferring large capital expenditure projects which typically give rise to significant irrecoverable VAT costs, until it is known whether the policy will come into effect. Input VAT suffered by schools on such projects would potentially be available to offset against VAT due on fees.
If you require further information about anything covered in this briefing, please contact Charlotte Black or your usual contact at the firm on +44 (0)20 3375 7000.
© Farrer & Co LLP, November 2023