The end of charitable status of private schools?

The Labour Party has now confirmed that it will not remove charitable status from private schools if it forms the government after the next general election but will impose VAT on fees and remove the exemption from business rates.

There are currently four principal tax advantages of charitable status for private schools:

• The fees they charge are exempt from VAT.
• They are entitled to business rates relief, albeit only at the rate of 80%. Anything more is discretionary.
• They are entitled to gift aid on gifts made to them by UK tax-paying individuals. They can claim from HMRC a sum equal to basic rate of tax (25%) paid by the donor on the taxable income out of which the gift was made, making the gift of £100 to the school worth £125. The donor can reduce their tax bill by an amount equal to the higher rate of tax payable on taxable income equal to the amount of the gift. A gift of £100 could cost the donor as little as £65.
• Gifts made to them are free of inheritance tax, whether on death or during the donor’s lifetime. If 10% or more of the deceased’s estate is given to charity, the rate at which inheritance tax is paid on the deceased’s estate is reduced from 40% to 36%.

In return for the tax advantages referred to above, those private schools which are charities are required to ensure that their expenditure is wholly and exclusively applied in furtherance of their charitable purposes, as set out in their governing instrument. They are also subject to the supervision of the Charity Commission. Not all private schools are charities as some are run to make profits for their shareholders. Nonetheless, because the provision of educational services is VAT-exempt, even non-charitable schools do not have to charge VAT on their fees.

The Labour Party is now proposing to make private school fees subject to VAT, presumably at the standard rate (currently 20%), and to remove the exemption from business rates on buildings occupied by private schools. Although schools will be required to charge VAT on the fees they charge, they will also be able to recover VAT on their expenditure. Usually, about 60% of a school’s expenditure relates to remuneration payable to its staff, which is not subject to VAT. But as much as 40% of their expenditure may well be subject to VAT and could be offset against the VAT they charge on their fees. Schools could therefore reduce their fees (because they are able to recover that VAT) and the full VAT charge need not be passed on to parents.

One of the principal concerns expressed by supporters of private schools was that the higher fees likely to become payable because of the loss of the tax benefits would result in parents sending their children to state schools. One can only guess how likely that outcome would be, but, on the whole, the results achieved by private schools, with notable exceptions, are significantly better than the results achieved in the state sector, and the long-term prospects of children educated in the private sector generally remain better than those educated in the state sector. Parents may therefore be slightly wary about removing their children from private schools partway through their education if they are getting on well there.

It has been suggested that, freed from the encumbrances of charitable status, private schools may sell their assets and distribute the resulting cash to their members. If the Charity Commission continues to supervise private schools with charitable status, that cannot happen. Indeed, any disposal of land owned by such a school would require permission from the Charity Commission and paying money to members of a charity is never allowed.

Private schools with charitable status would be required to continue to further their charitable purposes and not to do anything else. The schools will therefore probably have to continue very much as they do now. If that is the case, they will need to try to balance their books by trimming their fees to retain their pupils and cutting their expenditure accordingly. Consequently, it is unlikely that the state schools will be flooded by private school pupils. A Labour government might not get quite as much tax revenue as it has forecast because the fees (excluding VAT) may have been reduced but it probably would not need to fund places for many thousands of private school pupils either.