How will Labour’s plans to introduce VAT on school fees impact private schools?

The Government has published its proposals to apply VAT to school fees. From 1 January 2025 all education services and vocational training supplied by private schools for a fee will be subject to VAT at 20%, as will related boarding services.

In this article, tax disputes lawyer Matheu Smith considers the challenges that may arise where parents have already prepaid fees in the hope of avoiding VAT.

The Government’s proposals say that any fees paid from 29 July 2024 pertaining to the term starting in January 2025 onwards will be subject to VAT. Many have interpreted this to mean that prepayments made before 29 July 2024 will not be subject to VAT; however, the position is far from so simple.

The Government goes on to say it is aware of reports of a recent surge in the use of prepayment arrangements to try to avoid the VAT Labour said it would impose, if elected. It tacitly acknowledges that prepayment arrangements can be effective, but emphasises how difficult that outcome is to achieve, indicating that in many cases the Government considers the arrangements will not be effective, stating “… HMRC stands ready to challenge the validity of such payments and will seek to collect VAT on those fees where it is due. Indeed, the government is committed to tackling tax avoidance and in line with the principle to ensure that the changes are fair and that all users of private schools pay their fair share, HMRC will be carefully scrutinising the detail of these schemes to ensure that schools pay the correct VAT where it is due.”

This indicates that in the next year or so schools may well find themselves subject to some form of HMRC enquiry to check whether they have participated in prepayment or other arrangements aimed at avoiding VAT. Where they have and HMRC considers the arrangements to be ineffective, HMRC will raise a VAT assessment requiring the school to pay the VAT. Of course, a school might seek to pursue legal proceedings in the form of a statutory appeal of the VAT assessment and it may eventually win. However, the process of going through an HMRC enquiry and an appeal will be costly and lengthy.

Typically, where many taxpayers have similar arguments with HMRC, some test cases may be fought, with most schools left awaiting the outcome of those. However, even those left waiting will have to bear the cost of dealing with an HMRC enquiry and perhaps starting a formal appeal to keep alive their right to contest whether they owe the VAT. Furthermore, it may be a wait of many years – it is not unusual for tax disputes to take over five years to resolve if test cases end up being pursued to the Court of Appeal or Supreme Court.

This may be particularly difficult for schools to manage, for example:

• Arguably there is little or no direct benefit to the school in fighting such a battle with HMRC; it is the parents that have prepaid fees who stand to benefit. Parents that have not prepaid fees will be very unhappy at seeing their school expend its resources dealing with an HMRC enquiry and an appeal, especially as such costs are not usually recoverable from HMRC even if the taxpayer wins. Indeed, disputes over whether it is proper for a school to use its resources to fight HMRC may arise.
• Schools may face the task of persuading parents that used prepayment arrangements to fund the costs of dealing with an HMRC enquiry and any appeal or will have to pay them out of the school’s reserves.
• Since disputed VAT must be paid as a precondition to pursuing an appeal, with it being repaid (plus repayment interest) if the appeal is successful, schools will have to get the parents that used the prepayment arrangements to pay the disputed VAT or pay it out of the school’s reserves. In some circumstances, HMRC can agree to defer payment of the VAT until the end of the appeal process. If the school did that and later lost the appeal, not only would it have to pay the VAT, it will also owe late payment interest, which currently accrues at 7.75% per annum. Furthermore, by the time the dispute has ended, the school may be left chasing parents of former pupils for payment of the VAT.
• Where the prepayment arrangements adopted by a school are found to be ineffective and VAT is due, the school may find itself in dispute with parents who refuse to pay the VAT on the basis that the school should have implemented effective arrangements.

The Government’s proposals are out for consultation until 15 September 2024 and it is to be hoped one outcome will be greater clarity about the treatment of prepayments made before 29 July 2024. This will hopefully mean schools will not be distracted from educating their pupils by battles with HMRC and/or the pupils’ parents.

If you have questions about the Government’s proposals to apply VAT to school fees, please contact Matheu Smith.