I wrote last year about a potential VAT earthquake for the education sector, specifically Further Education colleges (“FE”). The Court of Appeal (CoA), has delivered this earthquake, confirming that “block funding” received by FE colleges is business income.
This insight considers the implications for the education sector.
Colchester Institute Corporation (CIC) v HM Revenue & Customs
The background leading to the CoA verdict is a long-running dispute between CIC and HMRC. The CoA confirmed that funding received from the Education and Skills funding Agency (ESFA), an executive agency of the Department for Education (DfE), is consideration for the supply of education services made by CIC.
The CoA agreed there is a direct link between the payment made to the FE college, and the education services provided to its learners.
HMRC can appeal one more time and take this matter to the Supreme Court. This is the final recourse to litigation.
What are the implications?
Pending a potential HMRC appeal, the immediate implications for FE colleges are clear. The funding they receive is business income, and by extension the provision of education by the FE college is a business activity.
Various VAT reliefs available for non-business activities will no longer apply to FE colleges. Most impact will be felt with the disappearance of relevant charitable purpose (RCP) relief used by colleges to construct VAT-free teaching facilities.
The cash impact of the loss of VAT reliefs may be offset by the availability of VAT reclaims, as FE colleges may now become liable to charge VAT on education fees (see below).
Less obvious is the broader application for the rest of the education sector. Many schools have now academised. Academies also receive funding from the DfE, calculated via a similar mechanism to which FE colleges receive their own funding. Will the application of this decision extend to the funding received by an academy? HMRC may be forced to revise their current view that academy funding is non-business, but academies can safely rely on the status quo until any changes are announced
Are FE colleges now subject to VAT?
On the surface, FE colleges meet the definition of a private school, in Part 3, Schedule 9 of the VAT Act 1994. Consequently, any consideration received by a FE college for the provision of education becomes subject to VAT.
It is unknown how HMRC will react to the recent CoA decision, however the UK government has previously acknowledged this. As part of its responses to the consultation for the application of VAT on private schools, it said:
“Institutions can, if they choose to, apply the conclusion of the Upper Tribunal in Colchester, which would result in them treating the public funds they receive as business income. This could bring these institutions within scope of this policy, as this income would be treated as consideration for the provision of education”
HMRC response
To date HMRC policy has been to not enforce the Upper Tribunal decision. It always felt a difficult position to justify, and the CoA decision makes it even harder.
HMRC will be expected to respond to this decision swiftly. They will need to decide whether an appeal to the Supreme Court is warranted. This will be the final opportunity for the decision to be overturned.
If the decision is not appealed, HMRC will need to provide urgent guidance, given its potential ramifications, and the prospect of overturning established VAT practice for FE colleges.
I expect to see a Revenue & Customs Brief, to confirm any new policy, followed by updates to published guidance.
Could we see a law change?
It is possible that rather than follow this decision, the Government change the law by legislating that this income is non-business. We have seen this approach before and the UK’s exit from the EU gives additional freedom in how the Government can legislate for VAT. A change in law would open even wider implications beyond the scope of this piece.
What are the options for FE colleges?
Colleges should consider the implications of this case immediately. Firstly, they should consider whether they qualify as a private school in Part 3, Schedule 9, VAT Act 1994.
Whilst there remains uncertainty over whether HMRC will appeal, it is viable for FE colleges to continue with the status quo for the time being. This is unlikely to cause any difficulty with HMRC, as it follows existing policy. If HMRC does appeal, it is unlikely there will be any policy change until litigation concludes.
However, the following options are available to FE colleges who identify they qualify as a private school
If the FE college is already VAT registered it has the option of charging and reclaiming VAT on education services immediately. This may be the most prudent approach to protect against penalties for underdeclared VAT.
If the FE college is not VAT registered, it may review its income and consider if an application to register for VAT is appropriate. Registering for VAT will help to mitigate penalties for failure to notify a liability to VAT registration. It may also open opportunities for historical VAT claims.
In both scenarios, the FE college will need to consider if its contract for funding with the ESFA allows for the addition of VAT on the consideration it receives. In our experience, the agreement is usually silent about VAT – so a policy change led the DfE may be the only route to charging VAT available to the FE college.
Conclusion
The CoA decision in CIC has wide-ranging implications for the education sector, and particularly for FE colleges. I would recommend that all FE colleges take stock of the decision. They should consider whether they qualify as a private school and review their income sources to understand the potential impact of VAT registration and VAT charges on DfE funding should HMRC choose not to appeal or subsequently lose at the Supreme Court.
If there are any issues or topics you wish to discuss further, please contact a member of our team.
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