26 January 2024

How could HM Treasury’s reform to VAT refund rules change how the NHS operates? Our healthcare VAT expert, Scott Harwood, looks at the impact for the NHS and wider healthcare sector.


VAT represents a sizeable proportion of the NHS budget. How it’s administered can fundamentally change how the NHS, and the wider sector operates. In the past HM Treasury have used this to great effect, but what will the future look like?


When VAT was first introduced in the 1970s the NHS, who couldn’t reclaim VAT, was funded to cover all their VAT purchase costs. Despite this, and as it was more cost effective to engage NHS workers directly rather than pay VAT to external suppliers, the NHS found itself growing into one of the world’s largest employers.

From the 1980s, to help manage this, the NHS has benefited from a VAT refund scheme known as the Contracted Out Services (COS). The underlying driver of this policy change was to encourage the NHS to outsource certain activity areas to the private sector, reducing the NHS worker count. This has, to an extent, been a successful policy with NHS worker numbers staying consistent. VAT was a powerful tool in fundamentally changing how the NHS operates.

The current

The healthcare system is very different these days with the NHS purchasing a greater array of goods and services and having increased interaction with other organisations. The COS rules have become difficult for the NHS to operate as a judgment call must be made against each invoice, a burdensome process fraught with risk. To maintain compliance with HMRC the NHS can spend significant fees with tax advisers to help audit their VAT accounts.

Recognising this issue, HM Treasury recently published a consultation to significantly alter the present VAT scheme. This is effectively giving the NHS a VAT rebate of all their costs, irrespective of whether an activity has been outsourced or not. The introduction of the new scheme has been delayed but is still expected to be implemented.

The future

The new scheme should simplify VAT accounting for the NHS. But what wider impact will this have on the NHS and care sector? We’ve highlighted below the areas we think could change how the NHS operates.

Inhouse or outsourcing: The number of NHS workers may increase
The economic incentive to outsource activities will have been removed and VAT will no longer be a procurement influencer for inhouse versus external facilities provision. Taking the example of a large imaging contract, under the current scheme, the NHS receives a VAT rebate only if they outsource the facility including operational staff. Under the new scheme, the NHS will be no better or worse off if they just buy the equipment and use their own team.

Temporary staff: Use of recruitment agencies could increase
The current VAT cost of engaging temporary locums and Allied Health Professionals [AHPs] will also be removed. Direct engagement models may no longer have a business purpose and the NHS could, feasibly, have less disincentive to use agency staff versus employed or bank workers.

NHS subsidiaries: Special purpose vehicles (SPVs) may disappear
One of the main drivers of setting up a subsidiary is the potential VAT savings. These can be used for pharmacy, facilities, IT and laboratory testing and may other areas. Remove the VAT saving driver and new or existing business cases may no longer stack-up.

Financial systems: There will be more choice
The NHS currently need bespoke financial systems or skilled back-office providers to cope with the current VAT rules. Under the new scheme there should be more flexibility of providers introducing more competition.

Advisor fees: Fees will not substantially reduce
A lot of the time costs are absorbed on VAT compliance work. These audit fees will reduce, but it should be noted they often subsidise more complex advisory work which is often undervalued. Inevitably HMRC will focus more on other tax areas (such as partial exemption, IR35) and advisor fees may be rebalanced accordingly.

Tax planning: Tax planning may actually increase
The Treasury consultation hopes the new scheme will reduce VAT planning in the sector. This is unlikely as suppliers will look to reposition non-taxable supplies to be subject to VAT, allowing suppliers to reclaim their own VAT costs. In turn, this may reduce the purchase cost for the NHS.

Keep watching this space
The new VAT compensation scheme for the NHS and its suppliers is a welcome change that will benefit both parties in terms of cash flow and compliance. There are still challenges and uncertainties that need to be addressed before the scheme can be implemented smoothly and effectively. 

How can RSM help?

If your NHS organisation would like support with VAT, please contact Scott Harwood.