VAT on independent school fees

Following the Labour Party’s manifesto promise to tax private school fees, the sector’s wait for clarification on what income streams VAT will apply to and when this measure will apply from, is over. 

The Chancellor announced on 29 July 2024 that VAT at 20% will indeed be chargeable on all education services and boarding fees, including vocational training, provided by private schools and any entity closely connected with them, from 1 January 2025.  In fact, according to Customs Brief 8 of 2024, any invoice raised or income received from the date of the announcement (29 July) to 1 January will also be subject to VAT if they relate to school terms commencing on or after 1 January.

The good news for schools that have implemented advanced fee planning arrangements is that fees and boarding charges paid up until 29 July will be treated according to the normal tax point rules at that time, i.e. they will be exempt from VAT according to the time they were paid.

There will be a consultation on draft legislation – which has also been issued by HMRC – although this will be for a very short period of just over six weeks and there is a question as to whether this gives sufficient time to consider those with specific issues the legislation and HMRC have not considered.

Which schools and entities will be affected?

In terms of which entities and the type of private education this will affect, the draft legislation states that VAT will be charged on fees at all ‘private’ schools (‘private’ being carefully defined) that provide full time education to pupils of compulsory school age, as well as those that offer education to pupils that are not of compulsory school age but are up to 19, such as sixth form colleges.  The type of education does not appear to matter.  Public sector institutions including sixth form colleges and academies will not be affected.

There are anti-avoidance measures covered in the draft legislation, particularly around advanced fees and any planning ideas to get other entities to supply the boarding accommodation apart from the education.  Clearly the intent is to tax all private school fees and to counter avoidance.

Exceptions to the VAT charge

There are some exceptions to the VAT charge, where fees will remain exempt from VAT.  These are nursery classes and schools that have been approved under section 342 of the Education Act, i.e. non-maintained special schools.  HMRC’s technical note explains that funding will be provided for pupils that are placed in a private school because their needs cannot be accommodated in state sector schools.

What is interesting, if you can call it that, is that whilst VAT will be added to school fees and to board and lodging fees (e.g. food and accommodation), other items that are closely related to the education and necessary for the tuition, i.e. those that you would have previously expected to follow the treatment of the education itself, will in fact remain exempt.  That said, HMRC have confirmed in their technical note that fees for extra-curricular educational activities, such as performing arts classes or sports lessons will be defined as education and so subject to VAT.  This will leave schools partly exempt and so with greater cost in administering VAT, and complexity such as in having to determine if a charge is for ‘education’, or not but closely related to that.

HMRC have said that schools that are not currently registered for VAT should not do so now, but await further guidance, which we assume will be released after the consultation end mid-September.

Let’s take a deeper look at what the current position is for private schools and what it will be in January 2025.

What is the current position?

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?

Guidance is, as mentioned, coming soon from HMRC.  But the ordinary position would be that with school fees becoming taxable, affected schools would 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 at 1 January 2025, or before if parents are required to pay for school terms in 2025 and beyond, a VAT registration will be required.  Until HMRC welcome applications schools will need to make sure their terms allow them to collect the VAT as and when the registration has been confirmed.

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?

As we have mentioned above, the VAT exemption for education also relates to supplies closely related to education.  The draft legislation confirms that these supplies will remain exempt from VAT despite relating to taxable tuition.

Partial exemption

It is anticipated that affected schools will make a mixture of taxable and exempt supplies, which 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.

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.

What should potentially affected schools be doing now?

Further detail may be needed from HMRC but there are a number of things affected schools should be doing:

• They should be looking at their contracts with feepayers, and amend accordingly, to ensure that VAT on any fees received between now and 1 January (and thereafter) can be charged.
• They should be 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.

We are getting increasing volumes of questions from clients on this topic, so if you need VAT advice on school fees or any other area, please contact us today.