Change proposed for VAT Recovery under Section 41 VATA 1994
Jan Garioch CA discusses HM Treasury’s paper VAT and the Public Sector: Reform to VAT refund rules.
HM Treasury is seeking views on proposals to change the rules for VAT recovery on goods and services incurred during the course of non-business activities by the NHS and Government Departments.
The problem
Following the Office of Tax Simplification’s review of VAT, published in 2017, the government has explored ideas for reform of Section 41 VATA 1994(s.41). That section was introduced back in 1984 as a facilitation to prevent VAT being a distortive factor for the NHS and government departments. Prior to that relief, the disincentive of incurring VAT prevented government departments from sourcing external services, even when the outsource would be the cost-efficient choice. The introduction of s.41 allowed listed bodies to recover VAT incurred on a list of contracted out services.
However, evolution of working practices has seen departments become more multi-faceted with more interaction with the private sector. This change has undermined the effectiveness of s.41 and produced undue complexity and administrative burden and, consequently, HM Treasury is seeking views on further change.
The (proposed) solution
HM Treasury’s favoured option for reform is to extend the scope of s.41 to permit full refunds of the VAT incurred on all goods and services during the course of non-business activities for those organisations which currently fall within its scope. An alternative approach of scrapping the s.41 regime of refunds and increasing budgets to offset the cost is not favoured by HM Treasury because it would not encourage departments to pursue activities cost effectively. (A third concept of enabling zero rating on supplies made to central government organisations is no longer under consideration because HM Treasury found it too far removed from current VAT rules and principles, and feared it would increase administrative burden for businesses interacting with the public sector).
Common sense
ICAS members have experience of the complexity brought by the current rules, and have been frustrated by the frequent changes in HMRC’s application of these rules. Therefore, moves to simplify the position for s.41 listed bodies make sense.
The change proposed would increase fiscal neutrality within the public sector as the VAT treatment for s.41 bodies would more closely align with that for s.33 bodies. It would not, however, arrive at full neutrality and it will be important to see any change implemented with due regard to where VAT distortions could be displaced to other parts of the public sector.
Good timing is key
During the ongoing COVID-19 crisis the risk of overburdening the NHS and related bodies has been acknowledged as a concern, so HM Treasury has confirmed it will not seek to implement any changes until the crisis eases. More widely, the transition of systems required to allow s.41 bodies to implement a full refund model will be substantial and require significant time to achieve.
A well-resourced HMRC team with public sector expertise will be essential to successful delivery of change, and open dialogue with public sector bodies and their external advisors is needed.
Any Member who wishes to submit their views, or contribute to the ICAS response submission, should note that the closing date for submissions to HM Treasury is 19 November 2020.