TAXline readers, as well as the general public, will be aware of the Labour party’s plans to end the VAT exemption for private schools. This policy – a renewal of the party’s 2019 manifesto – was announced by Sir Keir Starmer at the party’s Brighton conference in 2021. With Labour strong favourites to win next year’s general election, private schools are wisely making contingency plans.

The current position

Where education is being provided for a charge by an eligible body, the VAT consequences are:

• the education provided is exempt;
• closely-related goods or services are exempt; but
• the sale of other goods or services are taxed in the normal way.

Eligible bodies are defined in paragraph 4.1 of VAT Notice 701/30. In practice, it is assumed that Labour would remove the exemption for private schools by changing the definition of eligible bodies rather than removing the education exemption.

Even where private schools can apply the exemption, they are often still VAT-registered, because in addition to school fees (exempt), they are likely to make some taxable supplies. For example, many schools have incidental property lettings. Although sales and rentals of land and buildings are exempt, there are numerous exceptions, which include properties that are subject to an option to tax. This means the schools are partly exempt and must operate a partial exemption method, which adds complexity.

Although the letting of space for sporting and recreational purposes is taxable by law, there are detailed exceptions to this rule, such as a continuous letting of at least 24 hours. I have seen an example of a school that wanted to let its swimming pool to a third party for 16 hours a day; the reason why it did not want to let it at all times was that, for safeguarding reasons, it did not want anyone unconnected with the school to have access to the pool late at night. But this meant that the exemption for continuous 24-hour lettings was not available. 

There is also an exemption for a series of at least 10 lets to a school, club or association, but five conditions must be met (among others, in relation to the intervals between each period, and the requirement for the grantee to have exclusive use). It can be cumbersome to ensure that all five conditions are met. Even then, it is not necessarily straightforward where the facilities are let to an intermediary who in turn lets them to the general public. The judgements in the cases Abbotsley Golf & Squash Club Ltd VAT Tribunal Ref: LON/96/148 and Queens Park Football Club Ltd VAT Tribunal Ref: EDN/87/91 are arguably inconsistent. 

The school might want to make the letting attractive to the end user by not charging VAT. However, the benefit to the school might be outweighed by the cost of VAT advice, especially if a special method were judged to be desirable.

Schools with incidental property lettings will often need to consider a partial exemption special method. Partial exemption involves a degree of expertise, acquired either by training or by the engagement of a specialist. Labour’s proposal to add VAT to school fees might not alter the situation for schools with incidental lettings, who might still be partly exempt.

Analysing the numbers

This brings us back to the proposal and whether it will raise the £1.6bn indicated by Labour. The think tank EDSK says not. By contrast, the IFS considers £1.6bn to be a reasonable estimate. 

Some pupils might leave their private schools if the VAT on fees were unaffordable. This would lead to higher government spending on new state school places. EDSK calculated that – based on an assumption published by the Independent Schools Council in 2018 that 25% of pupils would drop out – the net amount raised would be closer to £19m. The IFS considers the drop-out rate would be much lower, requiring only £100m-£300m in additional state school funding.

If private schools are forced to charge VAT on school fees, they will become eligible to reclaim VAT spent on school buildings. This could go back up to 10 years because of the capital goods scheme. If a school spent £250,000 plus VAT on a building project, it would not have been able to recover most of the VAT because it was attributable largely to exempt supplies. But if these exempt supplies become taxable within 10 years, a proportion of the original VAT becomes recoverable.

There is also the possibility that parents will want to pay school fees several years in advance in order to avoid VAT (school fee prepayment schemes are not uncommon). However, if the exemption was abolished, it is likely that anti-forestalling rules would be introduced to prevent any tax leakage. 

Would abolishing the exemption make VAT simpler?

In February 2017, ICAEW hosted a meeting with the Office of Tax Simplification (OTS). Much of the discussion centred on measures that could be taken to simplify the VAT system, for example by making reliefs for charitable and educational buildings easier to administer. The abolition of many exemptions was also mentioned.

In 2019 the OTS launched a call for evidence on the simplification of the VAT partial exemption regime. Among the responses were:

• The time taken to obtain approval for a partial exemption special method is excessive.
• Allowing businesses to apply special methods without approval could simplify the system.
• The de minimis test is too complex, and the thresholds should be increased.

As mentioned above, private schools also need to consider the VAT treatment of land and buildings. The option to tax is often misunderstood, and a common misconception is that an option automatically passes to the purchaser of a property. If the purchaser wishes to opt the property, a conscious decision must be made and HMRC must be notified. If it becomes apparent several years down the line that no notification was given to HMRC but VAT has been charged on rent and recovered on expenditure in the meantime, the owner must attempt to convince HMRC that the intention was always to opt to tax, and this is rarely straightforward. 

At the 2017 meeting, one attendee suggested that all rents and sales of commercial property should be taxable, leaving exemption to apply only to charitable and residential property. Even this would not necessarily achieve the envisaged simplification – how does one define “commercial”, for example? The existing issues on business and non-business activities, which Revenue and Customs Brief 10 (2022) attempted to address, would still be present. 

One of the most complicated areas on the VAT statute book relates to the anti-avoidance provisions for options to tax (which apply when the property owner intends to let to a connected person who makes exempt supplies, and the property cost more than £250,000). If all commercial property were taxable, these provisions could be removed. But this would add costs for tenants making exempt supplies that cannot recover the VAT incurred on the rent. 

Fees for nursery-aged children in private schools, and wraparound care of children, are VAT exempt as welfare services. Fees for boarding could, on their own, be exempt from VAT. This adds to complexity.

Most of the other exemptions are subject to complex exceptions, such as finance, health and welfare, sport and recreational activities, and education.

Delegates who attended the Tax Faculty’s conference VAT at 50 on 22 May 2023 will recall that a key theme was the simplification of VAT. Taxing education broadens the tax base because a higher proportion of supplies will be subject to VAT, and in doing so reduces complexity. The education exemption can be complex to administer as education providers must work out whether they qualify as eligible bodies. This is not helped by the fact that many education providers also supply sporting services, and the definition of “eligible body” differs in this case (for sporting services, there is a requirement that the supplier is not subject to commercial influence, which means that the supplier has to analyse transactions with its officers).

Final thoughts

So does Labour’s proposed policy help to simplify the VAT system by removing the complex education exemption? Perhaps – although it may not raise as much for the public purse as Labour claims. And Labour is also proposing to keep special needs schools exempt from VAT, which itself adds a complexity. 

It’s an uphill battle trying to simplify the VAT system. Perhaps the answer is to abolish all exemptions and charge VAT on everything!

Peter Hughes FCA, P D Hughes Consultancy Services, member of ICAEW Tax Faculty’s VAT and Duties Committee