What are the potential consequences from a legal and financial viewpoint of Labour’s commitment to look at the tax benefits enjoyed by charitable independent schools and to levy VAT on education for all independent schools?
This briefing note was jointly authored by Tina Allison Head of Education at Crowe and Kristine Scott, Head of Education, Harrison Clark Rickerbys.
The possibility of a future Labour government and specifically their commitment to end tax exemptions for independent schools that have charitable status, has generated a fair amount of debate and press interest recently. It has also generated queries nationally from schools that are concerned as to what any change could mean for them. Although the detail of the proposal is yet unclear, the proposed change may include the removal of charitable status enjoyed by many independent schools and includes the VAT exemption on independent school fees, allegedly generating an estimated £1.7 billion to the Exchequer.
As of today, the proposal is just that, and there will be hurdles prior to enacting any such change. There is heartfelt concern within the sector as to the impact of the Labour commitment, including further rising school fees, potential loss of pupils due to affordability, and potential closure of some independent schools which will no longer be sustainable. There is also the suggestion that any removal will fuel faster growth and consolidation in the independent school market and drive school groups to expand and form at a faster rate. This note looks at a high-level as to what any change would mean for the independent sector from a legal and financial viewpoint.
In summary, schools should not, in our view, be looking to make any structural or governance changes now other than in pursuit of a school’s current medium to long-term strategy. It is important that schools respond to the current risks to the sector, and understand their governing document and current powers, and if change is necessary in the future, schools will be in a strong position by ensuring that their current structure and governance is fit for purpose.
What would full removal of charitable status mean for schools?
If there were to be a full removal of independent schools’ charitable status and no new regulatory arrangements put in place, schools would need to consider a number of issues including structure, operations, land disposal, and finance. As charities, schools are required exclusively to pursue their charitable objects. With the removal of charitable status, schools would become like any other commercial business (subject to the regulation applicable to the education sector). They would no longer be required to act in the public benefit and, subject to relevant constitutional changes, could engage in a wider range of activities. A school’s governing document will contain provisions and references which are likely to be inappropriate or irrelevant if it is no longer a charity. Schools would no longer be subject to the restrictions that charities face on trading. There would no longer be a need for trading which is not in pursuance of the objects to be conducted through a trading subsidy.
As a starting point, schools should be familiar with what they are able to do within the structure of their current governing document or constitution. If your school is thinking of restructuring, it is important that any change is considered alongside the medium- and long-term strategy of the school. It is necessary to consider what works well now and why there is a need for change. Most often we see restructuring when the business starts to diversify its income stream. Most commonly this involves establishing trading companies, as these activities are either outside the objects of the school or the risk needs to be ring-fenced. It is always important to bear in mind the financial effect of any restructure. Focussing on one reason can result in the cash being in the wrong entity, creating cashflow and working capital issues which can become complex to resolve.
If any incoming government stops short of a full removal of charity status and instead restrict its advantages specifically in respect of independent schools, this could mean that, whilst they remain subject to all the restrictions which accompany being a charity, they lose the tax advantages. Independent schools may therefore wish to take advice at an early stage about how best to manage their assets and consider hiving off certain activities such as grant-making into a standalone charity which is more likely to be authentically able to obtain – and retain – charity status and its full tax advantages. In order to consider this as part of any strategy, being familiar with current powers is an important starting point.
Since Britain left the EU, it has become far simpler to change VAT legislation, therefore if there is a political willingness to apply VAT to the supply of education it is relatively simple to do. Whilst the provision of education is currently an exempt supply it is not inconceivable that legislation could be drafted to make independent schools fees subject to VAT. There are very few remedies to this position other than looking at the VAT that can be recovered so only the net cost is passed on to the parent, but nevertheless for many schools it will represent a significant increase in the fees charged. Faced with VAT on school fees and the potential loss of pupils, some schools may consider becoming an academy.
An interim planning measure which may be possible is utilising a Fees in Advance Scheme. Many schools have these in place already. Parents pay a lump sum to the school and in return receive a discount on the fees charged by the school. It is important to note the school should not fix the fees charged for future periods but instead the fee inflation risk should remain with the parent. The physical receipt of fees in advance of providing educational services will crystallise a tax-point for VAT purposes. This means if the VAT rules change in the future the amount received in the fee in advance scheme prior to any announcement of a change, would not be subject to VAT. It is important that the school has full, unfettered use of the income to create the tax-point and so terms and conditions should be reviewed with this in mind.
It is important to remember when establishing a fees in advance scheme that it needs to be carefully managed. The discount rate applied should be set at a level where the school does not experience a loss on this transaction. Many schools already operate such schemes and if managed properly they can be attractive to parents whilst also helping the school’s cashflow. However, they are not without risk. It should be remembered that whilst you may use the cash balances taken, they do need to be available to meet the operational cashflow needs of the school on a timely basis. You may attract significant sums which heightens the possible money laundering risks, and in the event of a closure of a school due to financial difficulties, the parent may lose their funds.
If VAT is applied to education, it may still be possible to retain exemption over services that fall under childcare through the current welfare exemption, providing that these services are supplied under a separate contract for a separate fee. Using a separate company to provide the care services would add a further degree of separation. For instance, it is entirely possible that a separate company could have a separate contract for boarding services or even for other pre or post school care, that are provided for a separate fee to achieve exemption over these services.
Whilst this might work for VAT, the practicalities of implementing this need to be carefully considered. Think about how the staffing (and the named employer) would need to be structured to match these two independent services so that pitfalls are not encountered. How would this fit within the pricing model of the school? In many boarding schools there is not a significant differentiation between a boarding fee and a day fee to keep boarding remaining attractive, if the childcare element was removed this could result in the school needing to look at its pricing structure for day and boarding students to ensure that both the childcare and educational elements properly reflect these services and prevent the school from losing fee income.
The ripple effect of trying to manage the VAT position for any school needs to be carefully explored before any changes are implemented. It is crucial to consider any unintended consequences that could arise or barriers to achieving the school’s strategy.
The suggestion of VAT on school fees may, in the words of some current Bursars, make the option for families of independent schooling unaffordable to many who currently choose an independent school.
In terms of practical steps, schools should not, in our view, make any changes to their governing document or look to restructure purely in response to the Labour policy commitment. If any change or restructure forms part of the school’s current medium to long term strategy, this should be the impetus for any change, recognising the benefits the school will gain not the possibility of a Labour government, particularly without any detail and the potential ripple effect of any such change being fully understood.
If any change to VAT was implemented, it would not be retrospective, and we would expect a transitional period where schools would have time to consider the impact of any change prior to it coming into effect and respond considering all options.
This note will be kept under review, and it will be updated as circumstances change, and in any event at intervals of not less than six months between now and the forthcoming election.
If you require further information, please contact Kristine Scott, Head of Education, Harrison Clark Rickerbys, or Tina Allison, Head of Education, Crowe.