Proposed changes for VAT on private school fees

Posted: 12/02/2024

It is widely anticipated that a general election will be held in the final quarter of this year.

The Labour Party has confirmed that it intends to remove the VAT exemption on independent school fees, as originally set out in its 2019 manifesto. 

If Labour win the election, it could, theoretically, make a change to the VAT rules relatively quickly once it comes into power, and as the change relates to tax, it may be possible for Labour to pass this amendment in such a way that it cannot be opposed in the House of Lords.

This article will set out the current VAT rules and consider how they may change, as well as looking at potential ways in which it may be possible to mitigate the increased costs associated with the removal of the VAT exemption.

Where are we now?

The current VAT rules are that education provided by an ‘eligible body’ is a VAT exempt supply. Therefore an ‘eligible body’ is not required to add VAT to any charge it makes for the provision of its supply of education. 

A registered independent school is included within the list of eligible bodies and therefore private school fees are currently exempt from VAT. A charity which provides education is also included in this list. Many independent schools therefore fall within two of the categories of eligible body. 

In addition, the provision of services that are ‘related to’ the supply of education are also exempt. This includes school meals, school trips, boarding accommodation, after-school care, catering and transportation. 

Where a business makes exempt supplies, it is prevented from reclaiming VAT that it incurs in its supply of education and related services, as set out above. 

What is changing?

Labour’s proposal is to exclude a supply of education by an independent school from the list of eligible bodies, including where the school is registered as a charity. This means that VAT at 20% would be due on fees paid once the change takes effect. 

If VAT is introduced for private school fees, it would be chargeable for all students. This is as a result of the VAT ‘place of supply’ rules, which provide that a supply between a business and a consumer is treated as taking place where the supplier is based, even where the fee payer is outside the UK. This means that international students would also be subject to the VAT charge. 

VAT is calculated on the amount that is charged for the supply. If a school provides discounts to staff, scholarships or bursaries, this lowers the amount that is charged. It will be the discounted amount that is subject to VAT, and not the full amount of school fees that would otherwise be due. 

How could the costs be mitigated?

Do private schools have to pass on the VAT costs to fee payers?
The starting position is that where a supply is made under a contract that is silent on the VAT treatment, there is an assumption that the amount charged is inclusive of any VAT due. It is unlikely that any private schools will be willing or able to absorb the entire costs associated with the introduction of VAT on school fees. To this end, each private school would be advised to check its contractual provisions with fee payers to ensure that its supply is not deemed to be VAT inclusive, so that it is able to charge the VAT to the fee payer.

As mentioned above, as the school will no longer be making exempt supplies of education, it will be able to recover the VAT that it incurs in making the supply. This would include:

• VAT charged by contractors carrying out repair and maintenance works;
• utility costs; and
• professional fees such as the fees of an accountant.

It would also include the VAT charged on more substantial capital expenditure such as building, refurbishment and renovation work, which is covered in more detail below. 

As schools will be able to recover VAT if fees become subject to it, the cost to a school of the introduction of the VAT charge on fees will not result in an uplift of the full 20%. It would be possible therefore for the school to pass on an increased cost that is below the full 20% rate. 

Each school should undertake an assessment of its potential VAT recovery so that it is able to estimate the actual cost of the introduction of the VAT charge, in order for it to decide how much of the charge should be passed directly to the fee payer. Clearly this will vary by school and may vary per year, so schools will need to ensure that the calculation is not based on a year where the amount of expenditure on which VAT can be recovered is unusually high.

Can fees be separately itemised to retain some services that are VAT exempt?
As mentioned above, there are a number of categories of supplies that a school may provide that are also VAT exempt. The expectation is that a private school (and a charity providing private education) would be removed from the definition of ‘eligible body’, but it is not yet clear whether the change to the VAT rules would extend to all supplies made by a private school.

If the only change made to the VAT rules is to the definition of ‘eligible body’, there are still a number of supplies that a school will make that are VAT exempt. If these supplies can be separately itemised and charged for, this part of the fees would still be VAT exempt. For private schools which also provide boarding services, this could result in a significant cost saving for fee payers.

What if fees are paid in advance?
A ‘VAT point’ is generally created at the time that the services relating to that supply are performed. If, at the time of the services being performed, they are VATable, VAT would be due on the supply. However, the payment for services in advance also creates a ‘VAT point’, provided that it is clear what the payment relates to. In principle therefore, any payments that are made prior to the VAT rules changing will be VAT exempt, even where the services are performed after the changes come into effect. In order to ensure that it is clear what the payment is for, an invoice should be issued which details this. 

However, in the past years there has been an increasing trend for tax changes to take effect from the date the change is announced (and not the date that the legislative change receives royal assent, which is often several months after), or on some occasions, retrospectively. If an advance payment system is put in place to mitigate the cost of the introduction of VAT on school fees, there is a risk therefore that these payments could subsequently become subject to VAT. If advance payments are used, schools will need to ensure that the payment terms permit them to pass on the VAT costs if the payment retrospectively becomes subject to VAT. 

Additionally, there may be a limited time to implement an advance payment system if there is a spring/summer election.

Can the school reclaim any VAT incurred prior to the rules changing?
The general rule is that the VAT rules in force at the time of supply will dictate whether VAT incurred is recoverable. If a school makes an exempt supply, it will not be able to recover any VAT it incurs making it.

If the school had taken advance payments which retrospectively became VATable, this would mean that VAT incurred in making the supply would also become recoverable.

However, with the change in the VAT rules, there is a potentially more significant reclaim available where the school has incurred VAT on building and maintenance projects in the ten years prior to the rules changing. This would include purchasing additional land, constructing a building or refurbishing, fitting out, and altering or extending an existing building (provided that certain conditions are met). This would only apply where the project cost (excluding VAT) was equal to or exceeded £250,000. 

Large building and maintenance projects fall within a VAT scheme called the capital goods scheme. The capital goods scheme requires the VAT treatment for such expenditure to be spread across a ten-year period, known as the ‘adjustment period’. Where the expenditure is incurred to make VAT exempt supplies, none of the VAT incurred is recoverable. This means that schools will not have recovered any VAT to-date on completed projects, given that the supply that is being made by a school is an exempt supply of education. 

However, if the VAT rules change and the school is making VATable supplies (at least in relation to school fees), the VATable status of the supply has changed, and if this change occurs during the capital goods scheme adjustment period, a proportion of the VAT incurred would become recoverable. 

The amount of VAT that would be recoverable would depend upon how far into the capital goods scheme adjustment period the school is, and the percentage of VATable supplies that the school makes after the change in rules (taking into account any supplies that continue to be exempt such as school trips, catering and accommodation as mentioned above). To give a simple example, if the school incurred VAT on a building contract five years prior to the rules changing, and its VATable supplies made up 50% of its overall supplies once the changes took effect, then a quarter of the VAT costs associated with the project could become recoverable over the remainder of the adjustment period. It should be noted that not all VAT incurred on the project would be recoverable and a detailed assessment would need to be carried out to determine what the school could reclaim.

As with all the other proposals, it would be possible for a Labour government to block such recovery at the same time as changing the rules on the VAT status of school fees, so the ability to recover for past building projects and acquisitions of land would need to be assessed once any amending legislation has been drafted. 

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