"Change begins now" says Keir Starmer, following Labour's landslide win. The Labour Party manifesto pledged to end the VAT exemption afforded to private schools. While precise timing is unknown, parents and private schools should anticipate a lot of change and also being out of pocket.
Labour plans to impose the standard rate of VAT on private school fees, which are currently VAT exempt, and could therefore force an increase in fees by about 15%. While the standard VAT rate is 20%, the increased cost is estimated to be around 15% as private schools will be entitled to VAT recovery.
This is causing a wave of concern and uncertainty for both private schools and fee-paying parents, who will ultimately take the hit.
More recently Labour have also announced plans to close in on a so-called 'loophole' of pre-paying private school fees, prior to these changes taking place, shutting down a 'pay now and save later' solution.
So, why the change?
The Institute for Fiscal Studies ("IFS") estimates that this change could raise ca. £1.6 billion per annum. Labour's plan is to invest this additional revenue into state schools, specifically targeting students from disadvantaged backgrounds.
When a business is VAT exempt, it is not required to charge VAT on sales it makes, however, in turn cannot recover the VAT charged to it on its purchases. This means that should private schools become taxable under Labour's proposal, they will indeed be required to account for 20% on the education services they provide. However, they will also be able to recover the VAT charged to them on costs they incur, which currently constitutes an absolute cost.
Whilst the £1.6billion figure from the IFS study does take into account the input VAT private schools would be entitled to recover on costs incurred if their exempt status is removed, it assumes only 20% of the costs they incur are taxable. This is on the basis that the majority of costs are staff salaries, which do not attract VAT. This appears reasonable. However, the figures themselves represent a broad-brush calculation and the reality of the what these changes will actually mean, will ultimately vary on a school-by-school basis. Applying the same broad-brush approach, private schools with lower fees are less likely to have significant capital expenditure and will therefore have lower VAT recovery. This means that the private schools at the less expensive end of the spectrum are most impacted by this change. This could have the undesired effect of creating an even wider gap between state and private schools.
How will the change be implemented?
The detail on how the change will take effect is unclear. However, a change to VAT legislation would be required. This is because currently private schools are included within the definition of an 'eligible body' (within Schedule 9, Group 6 VATA 1994) and only eligible bodies can qualify for the exemption. It is also unclear on what legal basis the VAT exemption would continue to apply for education provided to children with education health care plans ("EHCPs") who are being educated in private schools because of the shortage of spaces in the state sector. This is what has been confirmed by Keir Starmer in this pre-election bid.
It is not just the exemption that Labour plan to strip away. Labour is also looking to remove private schools' business rates relief.
Together these two changes will undoubtedly have an impact on private schools, and – could there be further changes coming? Watch this space.
When could this happen?
There is no definitive timeline set at this stage, however we expect this would not take effect in advance of the academic year 2025-26. Nevertheless, we note that obtaining an Act of Parliament to pursue a change in legislation will take a while.
How will this affect private schools?
Clearly this is going to hit private schools hard. The worst-case scenario, as has been publicly spread, is that private school fees will be increased by ca. 15% to ensure business continuity.
Depending on the profile of the school investments, VAT recovery on costs (utility bills, construction and repair work and professional fees) could allow some schools to reduce the potential fee increase as much as possible.
It is now a tricky time for private schools trying to weigh up the VAT saving versus the VAT cost to calculate by how much they need to increase fees.
So, will these mean students will be forced to drop out? It is very likely that some students will be forced to change schools to state schools. It is more likely that siblings and younger students will never have an opportunity to attend private school. Alongside the cost-of-living crisis we are experiencing in the UK, there will be many parents unable to meet an increase in fees.
Remember, the fee increase will also apply to international students. Parents living abroad, who enrol their child into a UK private school, are already required to prove they have at least nine months of course fees in their bank account, when applying for a Child Student Visa. This means they will have a significant chunk of change to source quickly if Labour do implement this next year.
It's not all doom and gloom!
Private schools which have, in the last ten years, incurred high capital expenditure, for example construction, refurbishment or renovation works over £250K, could actually find a benefit from the proposed changes. This is because an exempt business is not able to recover the VAT it is charged on such costs. However, the capital goods scheme (CGS) tracks the intention/use of these costs over a ten-year period on an interval basis.
As a result, a private school which finds itself within the scope of CGS may have a right to recover VAT on historic works undertaken. If these costs are significant, there could be a big saving due in the form of a VAT repayment from HMRC. Further, if private schools do become taxable businesses, they will no longer suffer the additional 20% VAT cost on capex as they previously would have.
Will VAT apply to all income received by private schools?
The current VAT exemption applies to services that are closely related to education such as school trips, transport, accommodation, meals etc. Most schools will not have historically needed to consider the VAT treatment of these supplies and should now consider if they can avoid attracting VAT by qualifying for other reliefs. These could include exemption for after school care, zero-rated transport, exempt sports pitch hire and potentially exempt or reduced rate accommodation for boarding schools. This will depend both on the legislative changes and also how schools charge for these items, and is likely to require some contractual changes in order to avail of such easements.
What can parents do to prepare and what is this "loophole"?
Due to tax point rules for continuous supplies of services, parents and their tax advisors have identified the opportunity to pre-pay school fees prior to any legislative changes removing the existing VAT exempt status.
Where services are continuous in nature (such as school fees), the tax point will be the earlier of:
- The timing of when the VAT invoice is issued; or
- When payment is received.
As VAT is not currently payable on school fees and associated goods and services, as a matter of law, any parent/taxpayer choosing to prepay fees does so under current law. As such this would not constitute tax avoidance or be seen by HMRC as exploiting a "loophole" in the legislation at this moment in time.
Nevertheless, it has been publicly confirmed last week that an incoming Labour government would introduce anti-forestalling legislation, which would apply VAT at the applicable rate for the relevant school year rather than at the time of invoice/payment. This means that there is probably little merit in making advance payments in order to avoid additional VAT charges.
How can A&M help private schools?
We would recommend that concerned private schools should conduct a readiness review to analyse the affect the change may have on them specifically.
Once the position and likely impact is clearer, a plan can then be made to mitigate potential negative implication of the changes.
Further, the practical implications will include a requirement to undertake partial exemption calculations; improve systems to be able to be able to separate different income streams with different VAT rates; implement ERP system controls and upgrades with new tax codes; review contracts to ensure flexibility to change fees; and update invoices to start applying VAT.
How can A&M help parents?
Our Private Client team are on hand to assist with personal tax advice where required and can provide a review of parents' tax affairs to help increase tax efficiencies and in turn improve cash flow for the purposes of meeting the additional private school fee costs. For example, this may include looking at available tax reliefs or considering the tax benefits of certain venture capital investments.
Sources:
MHA | VAT Private Schools Fees & a Labour Government
Tax, private school fees and state school spending | Institute for Fiscal Studies (ifs.org.uk)
Shoud l be concerned about VAT school fees | Creaseys
Axing tax breaks would have small effect on private school pupil numbers – IFS | The Independent
Private Schools' Charity Status: Threats and VAT Exemption Insights (birketts.co.uk)
Labour to shut pay in advance loophole in VAT raid on private school fees (telegraph.co.uk)
Child Student visa: Money you need - GOV.UK (www.gov.uk)
Originally published 10 July 2024
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.