The Labour Party has announced its proposal to end the VAT exemption on fees for private schools if they win the next general election. Currently, private schools benefit from an exemption from VAT by two means: the first is under the general exemption for the provision of education by eligible bodies, and the second is by qualifying as a charity and benefiting from the VAT exemption for charities.
Ending these two exemptions may be simple enough, but VAT is a complicated area of tax law with several intricacies which could impact the amount of revenue the measure returns. The IFS estimates that removing tax exemptions from private schools would raise £1.6 billion a year in extra revenue (after allowing for input tax deductions, VAT on boarding fees, and exemptions for specialist provisions). This is broadly in line with the Labour costings document which has estimated the revenue raise to be £1.5bn in the tax year 2028/29.
Tax Consequences and Challenges
The tax consequences of the change are not straightforward. This is in part due to VAT being a tax on the value added to goods and services, which is achieved by requiring the supplier of a good or service to account to HMRC for the VAT (known as output tax), but the supplier being able to reduce the amount that they owe to HMRC by the amount of VAT they have paid when receiving goods or services (input tax). A supplier making exempt supplies will see some or all of its input tax recovery limited, so the removal of the VAT exemptions for private schools may result in a better input tax recovery position.
The interaction between output tax and input tax can create some strange results, with taxpayers sometimes able to obtain material credit for their input tax relative to their output tax. While current modelling from the IFS estimates that private schools would achieve an effective tax rate for VAT purposes of c.15%, this may be reflective of the current structure of private education services and pricing for it, and schools have not yet considered how they might organise themselves to be the most efficient that they can be.
A difficulty a Labour government would face is ensuring that the legislation ending the exemption for private schools works as they intend. They may want to ensure that schools cannot split out their services in a way which reevaluates the cost of teaching and accentuates the cost of other services which are VAT exempt such as after-school care and accommodation. Doing so in a way which does not accidentally capture childcare or special needs services provided by state schools or within communities may prove to be very challenging and could have unintended adverse consequences if it led to a rise in the cost of those services more generally. Further consideration may need to be given to the potential availability of large refunds where large capital expenditure has been undertaken in the previous ten years.
A Labour government would also need to give considerable thought to what anti-forestalling measures it may wish to include. Anti-forestalling measures are designed to prevent a taxpayer from taking advantage of a period before a measure comes into effect to mitigate unreasonably the impact of the upcoming measure. For example, many schools already give parents the opportunity to pre-pay school fees, to help families and schools manage future costs. Would any changes include anti-forestalling measures to prevent schools offering arrangements where parents pay in advance (and under the current VAT exemption) for education, and thereby save VAT on the fees? If so, when could such an anti-forestalling begin from (it could range from the date of any manifesto announcing the measure, the election day, the date that legislation is first put forward for the change or the date that legislation becomes law) bearing in mind fairness and principles governing retrospective taxation? There is no detail in the manifesto on this.
An interesting assumption made in the IFS paper is that a reduction in the number of pupils in private school education resulting from the VAT changes (and therefore not paying VAT on the fees under the new system) may not lead to a net reduction in VAT raised by the change, on the assumption that if parents have additional cash as a result of not paying fees (and VAT on those fees) for private school, they are likely to spend it on other things generating VAT receipts. This may be true, but the IFS do not seem to have considered that the reverse may also be true – for families needing to find additional cash to pay for private school, there may be a corollary reduction in other (VATable) spending?
