How to avoid VAT on private school fees, and how attempts at avoidance could go very expensively wrong

Labour seems set to introduce VAT on private school fees. We thought it would be helpful to set out the ways some private schools might try to avoid VAT, and our assessment of their prospects of success. We’ve identified some approaches which we’ve categorised as “good” (likely to succeed), “bad” (likely to fail) and “ugly” (highly inadvisable and maybe even criminal).

Please note two important caveats:

• We’ve written this to help advance the debate, and inform private schools and parents of the issues they may wish to consider. This is not legal or tax advice, and anyone considering implementing any of the approaches we discuss should speak to a suitably qualified tax professional.
• The question as to whether VAT should be charged on private school fees is a political question on which we take no position. The question as to the wider impact of charging VAT on the private and state sectors is an education policy question where we have no expertise (we wrote about the issues here). This article focuses solely on the question of how the VAT could be avoided.

Why VAT planning is high risk for private schools

Here’s the big problem: if a school takes any steps to reduce the overall VAT it charges parents, and that goes wrong, the school would have a very large liability.

The reason is that, if a private school doesn’t charge VAT, and HMRC disagrees, then HMRC will have at least four years to challenge the position. HMRC can then assess the school to VAT and it will then immediately have to pay.¹It’s slightly more complicated than this; taxpayers have the right to first seek an internal HMRC review, but in practice that almost never changes the outcome.

The school would be able to appeal but, unlike income tax and other direct taxes, the school would have to pay up-front first, and then spend likely at least two years in an appeal process.

This creates a very significant practical risk for schools engaging in any VAT planning. The planning could appear to succeed and the school hear nothing for four years; then a sudden HMRC enquiry could result in it having to pay four years’ worth of VAT, plus interest, plus legal fees, all in one go. In other words, an amount broadly equal to one full year of fees (plus potentially penalties too).

In principle the school may be able to recover this from parents. That would however require specific wording in schools’ contract with parents, providing for an indemnity in the event HMRC asserts the school charged VAT incorrectly. The current standard form school contract doesn’t do this²There’s optional language saying fees are exclusive of tax, but that’s not enough to create a four year indemnity.

Even if the contract in principle enabled recovery from parents, the practicalities would be difficult. Some parents would be abroad. Others may not be able to pay. Many would have left the school. All will likely be unhappy. Parents may be able to argue that they are not bound by an indemnity, for example because the school did not fully disclose the risks, and the indemnity is therefore unenforceable (the Consumer Rights Act applies to private schools’ contracts with parents).

We therefore conclude that it is imprudent for any school to engage in VAT planning beyond the extremely simple and vanilla (the “good” items we identify below). Anything further presents a risk that any prudent school should regard as unacceptable.

Note that it doesn’t matter what advice a school obtains – accounting firms, KCs, whatever. If HMRC challenge the arrangement (and if it’s one of the ugly ones below, they will) the tax will have to be paid up-front. And in our view HMRC will win any appeal on these structures.

The good – a year’s fees in advance

Say the election is held in October 2024. What if parents pay a full year’s fees in September 2024 rather than, as is more normal, paying for each term shortly before it starts?

From a VAT point of view, VAT will be charged at the point an early payment is made. So the applicable VAT rules would be those in September 2024, and there would be no VAT. If there was an October 2024 Budget imposing VAT on private school fees, then that wouldn’t ordinarily change the VAT chargeable the previous month.

We say “ordinarily” because, in principle, Government could legislate retrospectively, so that fees paid in advance prior to the Budget became subject to the new 20% rate. That would be unusual, and we would be surprised if it were to happen. A prudent school may, nevertheless, wish to explicitly reserve the right to charge VAT if the legislation is retrospective.

On the other hand we will almost certainly see “anti-forestalling” rules. The Government might announce very quickly after the election that it will apply 20% VAT to private school fees. However the actual legislation would take some time to finalise and pass, particularly if (as would be wise) there is a consultation on the detail.³The usual timeline would be draft legislation published for consultation say in January, to go into the Finance Bill in March/April and obtain Royal Assent in July. That creates a protracted period during which people could seek to pay months and even years of fees in advance. A wise Government would therefore announce that any payment of more than a term’s fees in advance, from the date of the announcement, will be subject to VAT. This approach has been previously adopted for other VAT changes.

Hence it would be sensible for any advance payment of fees to be made well in advance of any announcement.

The theoretically good – several years’ fees in advance

In principle paying several years’ fees in advance of an election should be just as good as paying one year’s fees in advance.

However it seems less likely to happen, for several reasons:

• There will be a limited subset of people who can both afford to pay several years in advance, and care enough about the VAT cost to try to escape it.
• Schools may be wary about locking in the current level of fees for several years, particularly in a relatively high inflation environment.
• What if parents have to move out of the area, or otherwise withdraw their children from the school – would they get the fees back?
• More dramatically – parents may be concerned that the school could close or even fail, with no assurance they’d get their money back.

If that’s wrong, and we did see widespread payment of multiple years’ fees in advance, then the odds of retrospective legislation would increase. It may be unwise for private schools to push advance fee payments too far. It would certainly be a good idea for them to explicitly reserve the right to charge VAT if in fact legislation is retrospective.

The also good

There are other reasonably uncontroversial ways schools can respond to VAT on their fees:

• Schools will be able to recover VAT on their “input” costs, for example IT equipment, rent (not relevant to most schools) and the cost of building/maintaining buildings. This may require updating their accounting systems.
• Under the “capital goods” scheme, schools will be able to recover some VAT for capital projects paid for in the previous ten years – previously these VAT costs would have been entirely non-recoverable.
• Some school clubs have historically been run by external providers, invoicing separately (e.g. music lessons during school or after-school clubs). Where the providers aren’t subject to VAT (because they are exempt, zero rated, or their turnover is too small to attract VAT) then this will likely continue after school fees become subject to VAT. But see “unbundling” below.
• There would be nothing wrong with schools responding to the VAT change by trying to increase parents’ charitable donations (as Labour do not currently plan to end charitable status). Charitable donations aren’t subject to VAT; they also provide school and parents with gift aid (effectively adding up to 80% to the donation). In principle, the more donations a school receives, the less fees it needs to charge.

None of these are avoidance.

The bad – legal challenges

We may see attempts to challenge the imposition of VAT on private school fees.

Provided the legislation is enacted competently, we see no realistic basis on which such a challenge could be made:

• EU law would have made it unlawful to simply scrap the VAT exemption for private school fees.⁴Although the conditions in Article 133 of the VAT Directive could have been imposed, which in practice would probably have amounted to the same thing However, post-Brexit the UK faces no such constraints.
• EU law principles such as fiscal neutrality might also have been used to argue that the imposition of VAT on private school fees is unlawful (we are sceptical); but post-Brexit such principles can no longer override UK law.
• One might argue that the abolition of the private schools VAT exemption infringes the Human Rights Act/ECHR. However, even in principle, the Human Rights Act cannot override primary legislation – all a successful challenge would do is provide a “declaration of incompatibility“, asking Parliament to think again. And in practice, Courts have deferred to Parliament on tax questions, and no ECHR challenge has ever resulted in tax legislation behind held to be incompatible with Convention rights (even in the case of retrospective legislation). Any argument around private school fees would in our view be weaker than previous failed challenges.

We would therefore caution parents and schools against wasting large sums of money on legal challenges with little or no reasonable prospect of success.

The bad – unbundling

It’s been suggested some services such as boarding school accommodation, after-school clubs, sports activities and transport (e.g. school buses) could be “unbundled” and charged separately, and continue to be VAT exempt.

We are doubtful this will work. The technical question is whether there are two separate “supplies” for VAT purposes (e.g. accommodation with VAT at 0% plus education at 20%) or one supply (education at 20%). The courts have held that the key question is whether the two supplies are “distinct and independent”, but added that a single economic transaction should not be “artificially split”. HMRC have a useful summary of the issues here.

The issues are illustrated by the BPP case. One company provided tuition, with VAT charged at 20%. Another company in the same group provided textbooks intended to be used as part of the tuition, with VAT charged at 0%. BPP argued these were two separate supplies. It succeeded because the supplies were truly independent – a significant number of students bought the books without attending the course, and a significant number attended the course but bought the books elsewhere (and it would have succeeded even if the same company had provided both tuition and books).

Private schools will struggle to show that “unbundled” supplies are really independent – it is unlikely they will be purchased separately from the education. The most obvious example is boarding: it’s usually only available to pupils at the school, and is often part of the history and ethos of the school. Eton is not realistically going to open up boarding to people attending other schools (and if they did so in theory, with nobody taking it up, that would not assist them). Furthermore, any “unbundling” faces the significant challenge that it will clearly have been arranged in response to the VAT change.

There may be some cases where “unbundling” succeeds, but (as we note above) the risk will be on the school, and it’s a risk we believe prudent schools will not take.

Nevertheless, it may be wise for a Labour Government to introduce specific unbundling anti-avoidance rules, to serve as a clear “stay off the grass” warning sign.

The ugly – avoidance schemes

We can imagine a variety of different types of planning/schemes people might employ to avoid or reduce fees. We don’t believe any of these will work, and some could even result in prosecution:

• Any attempt to tie donations to the provision of education would likely make that “donation” a fee, subject to VAT. If schools went further, and disguised a fee as a donation, then could potentially amount to criminal tax evasion.
• For example, a school could try to game donations by quietly hinting that the children of people making large donations would receive full scholarships. But then the donation is, realistically, a fee, and subject to VAT. If the arrangement is hidden from HMRC then it could again be regarded as criminal.
• A few people have suggested creating offshore entities owning the schools. That wouldn’t change anything. VAT is charged based on where the school “belongs” which impact means where the education takes place. So if a school actually moves to Ireland, with teachers in Ireland and children educated Ireland, then that would indeed escape UK VAT. But just moving the company achieves nothing.
• A parent’s employer might think it could pay for their children’s education, and therefore recover the VAT cost. That doesn’t work, because the supply from a VAT perspective is from the school to the parent (reimbursed by the employer). The employer cannot recover the VAT. A variant on this would involve a company owned by the parents themselves – that risks heading into criminal territory.
• A variant on this: school could hint that if a parent’s company sponsors an event or building then their children would receive full scholarships. The company would ordinarily be able to recover VAT when it buys advertising/sponsorship. However again it would be clear the “sponsorship” is really the payment of school fees for the benefit of the parents. If hidden from HMRC the arrangement could be regarded as criminal.
• We don’t think unbundling is a very good idea, but an even worse idea would be to load a disproportionate amount of value into the unbundled items, for example charging thousands of pounds for textbooks or school uniforms, and asserting the 0% VAT rate applies. This again risks prosecution.
• Schemes where parents appear to pay several years of fees in advance, but in reality don’t. They keep the money and the school only gets it slightly ahead of each term, as it normally would. For example, you pay say five years’ of schooling up front with no VAT, but funded with a loan from the school. You pay the loan back over time with interest, and the payments just happen to equal the fees you would have paid normally. Any such scheme would be highly vulnerable to challenge (particularly if, as may be inevitable, failing to keep up with the interest payments means that your child can no longer go to the school – it is then clear that this is not interest, but a fee).
• We can imagine even more aggressive structures – for example a school moving to a model similar to hairdressers or a strip club, where each teacher/sports coach is an self-employed independent contractor sharing premises. The school provides billing and coordination services but the teachers don’t work for the school. Most of the teachers are under the VAT threshold (or the private tuition exemption applies), so all the teachers’ fees would be free of VAT. This, however, seems wildly impracticable – we doubt most schools could be run consistently with this model, although possibly very small schools could (e.g. with just two or three teachers).
• Independent special schools would likely be exempt from the new rules. There is a designation process for these schools – it is possible some schools might try to obtain a special school designation that should not be applicable to them. Again that could amount to criminal tax evasion.
• A school could split into multiple separate companies, each below the £85k threshold. There is specific anti-avoidance legislation to stop this, and it’s an area where HMRC is very active.
• We might even see “structured” solutions, such as converting a school into an company with parents subscribing for shares – the subscription of shares is not normally subject to VAT. Or perhaps an LLP with teachers and parents as members. All such structures are highly unlikely to succeed given the obvious reality of the arrangement – that the parents are paying to receive a service.

We don’t think specific rules are necessary to prevent any of these schemes, as we believe all would clearly fail. There will probably still be some people who try them, but that would be the case regardless of what anti-avoidance is introduced.

The bottom line

Whenever engaging in any tax planning, or indeed any legal transaction of any kind, a good question to ask is: “What’s the worst that could happen, and what would my liability be?”. The answers in this case suggest that trying to avoid VAT on private school fees will almost always be a bad idea.

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Thanks to C for the first draft of this article and V for HRA/ECHR input. Thanks to Q for reading through the final draft. Most of all, thanks to all the people who contributed avoidance ideas on my original Twitter and LinkedIn threads.

Piggy bank image (c) exampapersplus.co.uk and distributed under a Creative Commons licence.

• 1
  It’s slightly more complicated than this; taxpayers have the right to first seek an internal HMRC review, but in practice that almost never changes the outcome.
• 2
  There’s optional language saying fees are exclusive of tax, but that’s not enough to create a four year indemnity
• 3
  The usual timeline would be draft legislation published for consultation say in January, to go into the Finance Bill in March/April and obtain Royal Assent in July.
• 4
  Although the conditions in Article 133 of the VAT Directive could have been imposed, which in practice would probably have amounted to the same thing