Changes in tax landscapes for independent schools

The addition of VAT to independent school fees has been a clear part of Labour’s manifesto and policy since 2017 – a measure that the Labour party has claimed could raise £1.6bn in tax revenue. While the Labour party has most recently commented that it will not remove charitable status from private schools, it has doubled down on its plans to withdraw both the VAT exemption and the 80% relief on business rates should it win power at the next general election.  

This contrasts with the confirmation in the 2022 Autumn Statement that the current conservative government does not intend to impose VAT on independent school fees, so schools and parents are left waiting to find out whether, when and how the change will happen.

Changing the VAT liability of private school fees sounds simple enough – one day the fees would be VAT exempt, the next they would have VAT applied (likely at the standard rate, which is currently 20%). But would this necessarily mean a 20% increase in school fees?  With VAT, there is often a domino effect resulting in other VAT considerations. For example, under current legislation, the addition of VAT to school fees would normally mean that VAT incurred by the schools on certain expenditure (previously irrecoverable) could be off set against the VAT charged on their fees. It was expected, as a result, that schools may have an entitlement to reclaim VAT on some historical costs, either due to being newly VAT registered and/or because of the availability of refunds for those having undertaken large capital projects over the last ten years (known as the ‘capital goods scheme’).  These reliefs are available to all VAT registered entities meeting the relevant conditions under the existing UK VAT legislation and are a consequence of having income (or additional income) which is subject to VAT. 

However, it has since been reported that Labour’s ‘plan to change the law to enable VAT to be levied on private schools fees will also block those schools from making historical claims before the new tax comes into force’.  Although the VAT legislation affords HMRC some discretion to allow taxpayers to reclaim VAT that was incurred prior to VAT registration, a wholesale block on the entitlement to apply the statutory provisions of the capital goods scheme would mean that independent schools will be treated differently to other organisations making supplies that are subject to VAT. Considering a voluntary VAT registration now could be one way of protecting against this potential risk.

A change in VAT liability also highlights the tax point rules which govern the date on which a supply takes place for VAT purposes. Could a VAT charge on school fees be mitigated or removed by parents paying for their child’s entire school education in full before VAT becomes applicable? Aside from question marks about the affordability of such initiatives, it is unclear whether a Labour government would introduce anti-avoidance measures to prevent this and at what point such rules would be effective?

The imposition of any such measures will clearly increase the financial impact of Labour’s plans and a growing concern that the burden of VAT will ultimately fall on families, as independent schools may have no option other than to increase fees, potentially pricing some out of the independent school sector altogether.

This in itself could have far reaching implications, with research for the Independent Schools Council published in 2018 suggesting that the movement of pupils into the state sector could cost the government more than £400m by its fifth year.

Despite the Labour party’s statement that it will now not seek to remove the charitable status of independent schools, it cannot be fully ruled out that a Labour government might also remove entitlement to use gift aid and corporate tax relief for private schools. Withdrawal of these reliefs would put yet more upward pressure on fees.  

The timing of any changes will also be critical.  Labour’s announcement stated that it would introduce tax changes ‘immediately’ after the election, giving schools little time to prepare for the financial impact or to take action by increasing fees to mitigate the impact of the additional tax burden. It might therefore make sense for any VAT changes to be introduced in a phased approach, perhaps with the rate of VAT applicable starting at a rate lower than 20% to start with, allowing Labour to meet its pledge whilst also ensuring there is not a sharp shock to private schools.  Alternatively, schools should consider lobbying for a delay in implementation to allow financial plans to be fully prepared and for changes to charging structures to be made.

Although, in the absence of any draft legislation, it remains unclear how such measures can be accommodated within the existing VAT and tax legislation and the principles underpinning it. The current political polls suggest it’s more a question of when rather than if tax rises will happen. Independent schools should start preparing now, beginning by assessing the potential tax impact based on various scenarios. Only once this assessment had been undertaken will schools be able to determine if they need to raise their fees, or if some of the VAT to be charged to parents can be absorbed. Once they understand the likely impact of tax changes on their current operating model, they will be in a much better position to manage delicate communications with parents and guardians.

Schools may also wish to use this opportunity to consider whether to adopt a new model for governance. For example, to separate the roles of charity trustees and company directors to provide greater focus on running the school under education law, being risk management compliant with charity law and pursuing public benefit objectives, whilst allowing company directors to drive commercial ideas and initiatives.