05 July 2022
Local authorities operate or fund thousands of loss-making sport and leisure facilities across the UK. Generally, while councils are not legally obliged to provide these services, they almost always do, as they are seen as an essential requirement in the community to help maintain a healthy population and provide much needed community space.
Historically, authorities were always required to account for VAT on their fee income from their leisure centres, so a large proportion outsourced the management of those centres to non-profit community trusts; often supported by perceived savings derived from VAT and business rates. This was beneficial as sport and leisure trusts would be entitled to apply a VAT exemption to their income and supported by a top-up fee paid by the authority.
In 2017, following a European court judgment in favour of the London Borough of Ealing, it was confirmed that local authorities could instead choose to apply the same VAT exemption as sport and leisure trusts. This may have prompted the ‘insourcing’ of some leisure centres back into the hands of local authorities. However, the fact that authorities’ sport and leisure income was made exempt from VAT meant there was a risk that they may not be entitled to recover all the VAT they incurred on related costs. This has proved to be a real disincentive to use the exemption option. In recent years, authorities have pushed harder for VAT reform, arguing their supplies of sport and leisure services are actually a ‘non-business’ activity, meaning that this income would not be subject to VAT, but the councils would nevertheless be entitled to full VAT recovery on their costs. To succeed, the local authorities would need to establish that these activities are subject to a special public sector legal regime and that this VAT relief would not distort competition with commercial sport and leisure providers, who are required to charge VAT to their customers.
Chelmsford City Council, Midlothian Council and Mid Ulster District Council took up the baton as lead cases for England and Wales, Scotland and Northern Ireland respectively. To the surprise of many, they succeeded at the First Tier Tax (FTT) Tribunal, where the court agreed that their sport and leisure activities were subject to such a special public sector legal regime. In Mid Ulster’s case, the court also agreed that allowing councils not to charge VAT on the activity would not distort competition in the local market. The FTT decided that it would need to conduct further hearings for Chelmsford and Midlothian to consider the distortion of competition point in the very different local market conditions in England and Wales, and in Scotland.
HMRC appealed the Chelmsford decision to the Upper Tribunal. After a complex analysis of the many strands of legislation that apply to local authorities, the Upper Tribunal has dismissed HMRC’s appeal, finding that various legal obligations that applied to the council when it delivered leisure services were sufficient to amount to a special legal regime, because private operators providing similar facilities are not subject to those same conditions. For example, local authorities are required to consider the impact of their leisure services on the economic, social and environmental well-being of their area, review price rises on admission fees in case this deters vulnerable groups from using their facilities, and to consult the local community on their leisure strategies.
We suspect HMRC will now concede this litigation and accept that local authority leisure centres are a non-business activity for VAT purposes. If authorities are indeed operating under different legal conditions compared to both private and non-profit providers, this may well lead to the courts concluding that their VAT advantage does not distort the market.
So, if local authorities ultimately succeed, what impact could this have around the country? For a number of reasons, many authorities have already been considering whether to bring their leisure centres (that are currently managed by a separate trust) inhouse again. If HMRC concedes and authorities are allowed to treat their sport and leisure income as VAT free, and are also allowed to reclaim their associated VAT costs, then it seems inevitable that private and non-profit providers will not be able to compete financially and most services will be returned into council hands. This may be an ironic outcome given that local authorities’ entitlement not to charge VAT on sports is subject to a distortion of competition test.
Kirsty Cumming, CEO of Community Leisure UK, the representative body for sport and leisure trusts has said in response to the prospect of local authorities succeeding in their bid to treat the activity as non-taxable:
“The latest ruling from the Upper Tribunal in the Chelmsford case is of great concern for our members. This ruling would, incongruously, result in significant distortion of competition in the landscape, and would risk decisions being made on the delivery of sport and leisure services purely on perceived financial benefits rather than informed decision making based on the needs of local communities. By distorting the existing landscape the charitable nature of the trust model, and the value of charity, would inevitably be undermined.”