VAT and Further Education – an uncertain future?
Jimmy Davies · Posted on: March 17th 2025 · read
Fresh litigation by HMRC and the imposition of VAT on private school fees have created uncertainty around what the future holds for the VAT treatment of ESFA funding received by Further Education (“FE”) colleges.
This article aims to provide its readers with an understanding of the present position, and the possible issues and opportunities arising in the sector in 2025 and beyond.
What is causing the uncertainty?
The uncertainty stems back to an appeal in the Upper Tribunal (“UT”) decided in late 2020. Colchester Institute Corporation (“CIC”) appealed against a HMRC decision to deny it a reclaim for ‘overpaid’ output VAT.
The details of CIC’s claim are not important, but one of the grounds put forward by CIC in arguing that its claim should be repaid centered on the funding it receives from the Education and Skills Funding Agency (“ESFA” – at the time this was constituted as two separate bodies). It contended that this is payment of consideration for a supply of services, that being fees for the provision of education to students aged 16-18.
Historically, HMRC and the FE college sector have been aligned, and the funding received by FE colleges from central government funding agencies has been treated as being outside of the scope of the VAT system. This was on the basis there was considered no link between the funding received and the provision of education by an FE college.
In the CIC UT decision, the tribunal judge found that the ESFA funding received by CIC has a direct and immediate link to its provision of education and is “consideration” for a supply of services. HMRC won the appeal on different grounds, meaning CIC was unsuccessful in getting its claim repaid. Decisions at UT are as a matter of law binding on both taxpayers and HMRC, however HMRC issued Revenue and Customs Brief 8/21 which confirmed they would not seek to impose this policy on the sector until the decision has been tested again in a new case.
HMRC have now identified this new case and to paraphrase The Who, meet the new case, same as the old case. It will be a new hearing in the long-running CIC saga and is due to be heard at UT in mid-2025.
Why is this important now?
Historically, payments for supplies of education within the definition of VAT Act 1994, Schedule 9, Group 6 have been exempt from VAT.
On 30 October, in the first budget of the new government, Rachel Reeves confirmed the prior announcement that VAT would now be applied to fees paid for the provision of education by a private school.
New legislation to be included in the VAT Act creates a Part 3 to Schedule 9, which carves out of the exemption education provided by a private school for a fee.
A private school is defined in Note 1 of Part 3, as
"(a) either -
(i) a school at which full-time education is provided for pupils of compulsory school age or, in Scotland, school age (whether or not such education is also provided for pupils under or over that age), or
(ii) an institution at which full-time education is provided for persons over compulsory school age but under 19 and which is principally concerned with providing education suitable to the requirements of such persons (for example, a sixth form college), and
(b) where fees or other consideration are payable for that provision of full-time education.”
The definition has two parts - Note 1(a) and (b). The school must be both a school or an institution within Note 1(a) and must also charge fees or receive other consideration within Note 1(b) to be within the scope of this legislation.
FE colleges which traditionally receive fees from parents for the education of their child are already captured by both Note 1(a) and Note 1(b) and thus apply VAT to the fees which they charge to parents of students attending the college.
FE colleges which do not receive fees from parents but receive block funding from ESFA are captured by the first part of the definition of a private school (Note 1(a)(ii)), if they predominantly supply education to students 16-18 years old. The government published an explanatory note to give further context to the draft legislation introducing VAT on private school fees which confirms this interpretation.
This is important in the context of the new CIC litigation. If the new CIC hearing decides the same way as the original hearing, and confirms that ESFA funding is consideration for a supply of services provided by an FE college, those colleges receiving this funding will also be within Note 1(b).
The government has acknowledged this possibility. In the bundle of documentation published alongside the draft legislation was a document titled “government response to the technical note”. In this, the government said:
“2.37 Regarding concerns that public funds received by FE institutions may be regarded as fees for private education and may be within scope of this policy as a result of Colchester, HMRC does not actively impose the Upper Tribunal’s decision and is taking steps to test the primary decision on the treatment of public monies via a new appeal. This means that it remains open to institutions that continue to treat such education as non-business to claim reliefs, where all the relevant criteria have been met.
2.38 Institutions can, if they choose to, apply the conclusion of the Upper Tribunal in Colchester, which would result in them treating the public funds they receive as business income. This could bring these institutions within scope of this policy, as this income would be treated as consideration for the provision of education.”
Rather confusingly for the reader, the government contradicts this later. Paragraph 7.1. says that the government expect income for publicly funded FE colleges to remain “exempt”. Presumably they actually mean funding will remain outside the scope of VAT pending the new CIC decision at UT, but it is not made clear.
An opportunity or a risk for the sector?
There are two options for FE colleges currently:
- Continue to treat ESFA funding as outside the scope of VAT ;or
- Apply the treatment decided in the CIC case and treat ESFA funding as consideration for a supply of education.
Both options come with uncertainty whilst we eagerly await the outcome of the new CIC decision.
If the new CIC case confirms what was previously decided at UT, i.e., that ESFA funding is consideration payable to an FE college for the provision of education to its students, then all being equal, if the college provides full-time education, which is suitable for students who are aged 16-18, then VAT should be charged.
This opens an opportunity for FE colleges to reclaim VAT on costs incurred which have a direct and immediate link with the education provided by the FE college. This will be recoverable as input tax on a VAT return submitted by the college.
It also closes a long-trodden VAT planning avenue for FE colleges. Claims for VAT relief on construction of buildings solely used for educational purposes will no longer be possible. The proper consideration of VAT at the outset of any construction project will remain imperative, i.e., will the building be used entirely for taxable purposes, and VAT be recoverable on its construction, or will it be put to both taxable and exempt use?
What will the future look like?
Unfortunately, at the time of writing it is impossible to answer this question. There are too many unknowns, the most obvious being:
- How will ESFA react if FE colleges begin to charge VAT before the new CIC case is decided?
- Will ESFA adjust funding levels to take account of VAT that colleges will be able to recover?
- Will the government attempt to change the law to remove FE colleges from Note 1(a) of the private school legislation?
- Will the decision in the new CIC case be appealed, creating uncertainty beyond 2025?
It is also possible that the new CIC case decides that ESFA funding model is outside the scope of VAT, and we continue the status quo for the sector.
What should FE Colleges do?
We understand that few colleges outside of CIC are applying this treatment to the government funding received. Conversations we have with FE colleges suggest that there is little planning for this outcome taking place across the sector.
Preparation in life is the key to success, and we recommend that FE colleges should take steps now to be ready for whichever outcome is decided in CIC.
There are several good practice actions that a college can take so that it is prepared for any changes that may arise:
- Determine whether it is captured by the definition of a private school within the new legislation.
- Review income and develop an understanding of the possible VAT profile of the college if the VAT treatment of funding does change.
- Develop a plan to be compliant with any requirement to charge VAT on fees. This will involve having software and accounting systems prepared and ready.
- Review costs, both historical and current. Historically, the focus should be on any capital items which attracted VAT.
- Be active within the Association of Colleges and get its voice heard.
Our VAT team welcome the opportunity to discuss this with your college. There is never a bad time to plan, and our dedicated team of experts are available to help with any aspects of this matter.
