Charities and Education update: VAT on independent school fees 

In the wake of the Labour Party’s success in the recent UK general election, the independent schools sector is awaiting detail of how in practice the new government will fulfil its manifesto promise of making private school fees subject to VAT.   

It is not yet clear how or when this government policy will be introduced, nor precisely which organisations and type of supplies the changes will affect, given that there is no draft legislation, nor any consultation that has been issued by government as yet.   

There are some recent reports suggesting that although the policy may well be announced in the next (autumn) Budget, the change will not be applicable until 2025, and probably from the start of the September term.  Some reports also suggest that legislation may not be retrospective, meaning that schools that have implemented advanced fee planning to counteract the VAT change may not face challenges to having exempted income received before that time in 2025.  However, there are also some comments in the news suggesting that Labour will counter avoidance, which could possibly include advanced fee planning, perhaps by introducing anti-forestalling legislation in the Autumn which is related to a forthcoming change in treatment, whilst not actually being the introduction of the amending legislation itself.   

We really do not know enough at this stage and so caution is still the best approach in our view.  This means that, if schools are receiving advanced fees, they should ensure that wording in parent contracts concerning school fees allow VAT to be charged in respect of prior income, if at some point in the future legislation means that VAT is due. 

Despite continuing uncertainty, there are some basic principles and potential opportunities that we can advise you of, including some next steps to prepare for the likely changes.   

What is the current position for VAT on independent school fees?

Currently, private schools (or rather, ‘independent schools’) are exempt from charging VAT on school fees, on the basis that they are mentioned in VAT law as ‘eligible bodies’ for the purposes of the VAT exemption on education.  Eligible body status also includes charities and not-for profit entities that supply education or vocational training, provided they are prevented from distributing any profit made, and reinvest any surplus from educational activities into further educational supplies, rather than being used to support some other purpose. 

In addition to the supply of education, certain goods and services that are ‘closely related’ to the supply (such as school trips, boarding accommodation, catering and transport), are also exempt from VAT.  Given that independent schools will be exclusively or predominantly making VAT-exempt supplies (at present) it follows that many will not be registered for VAT, and would not be able to reclaim VAT incurred on their costs and overheads.   

What are the basics for having to register for VAT?

With school fees becoming taxable, affected schools will need to monitor their rolling annual taxable income against the VAT registration threshold (recently increased to £90,000), and register for VAT within 30 days of when they breach that threshold.  Remember, the value of overseas agent fees for pupil recruitment also adds to the taxable turnover threshold, something which is currently an issue in the sector and often leads to larger schools having to register and account for ‘reverse charge’ VAT on these services. 

You should note that there is a further registration rule that, if a school expects its taxable income in the next 30 day period alone to exceed £90,000, it would have to register from the date that expectation arose, i.e. before receiving that income.  This means in practice that as and when the VAT change happens, and as soon as school fees are about to be required from parents, a VAT registration will be required. 

Schools will be required to file regular, quarterly, VAT returns to account for 20% VAT on the school fees and (potentially) closely related revenue collected, but they will also be able to deduct VAT incurred on expenditure, including overheads and those of a capital nature.   

Given that schools will be entitled to deduct VAT on expenditure from VAT amounts due to HMRC, this may allow some schools to decide not to increase fees by the full 20%, but to calculate the amount on which VAT is added after having calculated the reduction in cost through VAT recovery.   

Does it matter who pays?

It should be noted that overseas feepayers will still be subject to the VAT charge, as the place of supply for VAT purposes is where the services of education are performed, regardless of the location of the feepayer.   

Where fees are discounted, and the school bears the cost of that discount, rather than a third party, VAT should only be due on the discounted amount. 

If a bursary means that a third party picks up the cost in full or in part, VAT will still be chargeable.  If instead the bursary is merely an agreement where the school provides the education free of charge, without a third party picking up the bill, then no VAT would be charged as no consideration is received.  However, a service supplied free of charge tends to be viewed by HMRC as a ‘non business’ activity, and such activities could have a detrimental effect on a school’s overall position on reclaiming VAT on costs. 

Are other VAT reliefs available for education?

As mentioned above, the VAT exemption for education also relates to supplies closely related to education.  It is not known as to whether new legislation will rely on the overriding tests in the VAT world that link ancillary supplies to the treatment of predominant supplies, or if it will maintain legislation similar to the current rules linking ‘closely related’ supplies to the (what will be taxable) education.  It is therefore to be established whether closely related supplies may be separated out from the main supply of education and potentially to qualify for other reliefs that are available.   

For instance, after-school care can fall under a separate VAT exemption for welfare services, and certain passenger transport services may be subject to the zero-rate of VAT.  It is not clear at this stage the extent to which such supplies could be disaggregated from the supply of education, but, if so, this in turn could mean that schools have the difficult task of managing mixed income treatment and partial exemption methods too.   

Partial exemption for VAT?

It is anticipated that affected schools may make a mixture of taxable and exempt supplies, which then will make them subject to the ‘partial exemption’ rules.   

Schools will need to carefully consider their position and determine if their expected level of recovery of VAT on expenditure, according to a ‘standard’ income-based partial exemption methodology, achieves a fair and reasonable result.  If it does not, expenditure may be subject to an ‘override’ provision, or the school may need to seek prior approval from HMRC to use a ‘partial exemption special method’.  

What about capital expenditure?

Whilst it is expected that this VAT change will allow independent schools to reclaim a significant proportion of VAT incurred on purchases, this will largely be in relation to current spending, noting also that newly-registered organisations have the ability to reclaim VAT on pre-registration expenditure (for up to six months before the effective date of registration for services, and up to four years for goods and assets on hand at the time of registration).   

Where a particular benefit may lie, however, is in regard to schools that have incurred VAT on capital items (for example new school buildings or renovations) costing over £250,000 plus VAT within the last ten years.  Schools should be entitled to reclaim a proportion of that VAT depending on how many remaining years of that ten-year period there are left.  This proportion will be determined by the relative split between the taxable and exempt (and/or non-business) use of the capital item.  In connection with this point on capital expenditure, we are aware that some schools are delaying capital projects, based on the likelihood that VAT will apply to fees.  In doing so, if VAT is incurred on capital works after VAT on fees has been introduced, this would give rise to an ability to reclaim upfront a substantial proportion of the VAT, rather than having to await an annual clawback from HMRC of one tenth of the recoverable VAT over a ten year period (if the works were begun before the change).  

What should potentially affected schools be doing next?

Whilst the detail is forthcoming, there are a number of things affected schools should be doing:   

• They should be looking at their contracts with feepayers, and amend accordingly, if they do not contractually have the right to charge VAT on top of the agreed school fees (including advanced fees). 
• They should start looking at their accounting software and processes and upskill relevant accounting and inputting staff.   
• They should start asking suppliers for proper VAT invoices and start extracting VAT from those invoices and recording that in their purchase ledgers. 
• They should perform an analysis on their overall commercial position, taking into account what may be reclaimable VAT on costs, as well as major items of capital expenditure incurred in the last ten years, to see how that can be offset against the VAT chargeable on the school fees. 

For further information and assistance in understanding how VAT may apply to your school, please contact Rupert Moyle, VAT and Duty Partner at Kreston Reeves LLP, or your usual Kreston Reeves contact.