VAT and public sector – ICAS calls for review

ICAS calls for a review of the current VAT regime for the public sector.

All those who work in VAT know it is far from a simple tax, and all those who work in the public sector know that these are not simple organisations. Where the two areas come together creates one of the most complex areas of tax in the UK. ICAS is calling for a review of the current VAT regime for the public sector to address this complexity and provide a level playing field for all organisations in the sector.

VAT and the Public Sector

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To illustrate the effect of this complexity, imagine a situation where services are transferred from a local authority to another organisation which does not fall into the VAT shelter for local authorities.  This will have an impact on VAT recovery – and an impact on budgets as VAT recovery rates fall from 100% to the rate for the new organisation. For example, consider a position where there is £1,000,000 of input VAT incurred on implementing a new payroll solution.  The VAT recovery position across public sector organisations would be:

  • Local authority – would be able to recover the £1,000,000 in full under the terms of the local authority VAT rules in section 33 VATA 1994.
  • Central government, NHS – would be able to recover the £1,000,000 in full under the terms of the VAT shelter for Central Government in section 41 VATA 1994 provided the services were covered in list of services where VAT can be recovered issued by the Treasury.
  • Other public sector organisations – universities, charities etc – if the organisation was able to be VAT registered the £1,000,000 input VAT would be treated as belonging in the partial exemption "pot".  Assuming a recovery rate of 15% (this figure is illustrative of the VAT recovery rate for the sector) would mean that the organisation would only be able to recover £150,000 of the VAT incurred, leaving it with a balance of £850,000 to cover with funding from other sources.

This example highlights the big impact VAT can have on the public sector.  For the local authority the cost of the services is the £5,000,000 net cost of the services provided, whereas for another public sector body providing the same services the cost in the illustration would be £5,850,000. This funding gap is significant.

ICAS is highlighting the following issues

  • As illustrated above, the differing VAT status of parts of the public sector provide a VAT recovery shelter to some organisations but not other organisations delivering the same services to the same end users.  There are strong arguments to suggest that the UK VAT system for the public sector is not fiscally neutral.
  • The differences in VAT recovery act as a disincentive to implement new and innovative service delivery models across the public sector. Moving activities traditionally delivered by an organisation within the VAT shelters to a new organisation unable to benefit from these will increase the costs of providing that service by 16.7% before any other changes are contemplated.
  • The administration of VAT in the public sector should be carried out by a specialist team within HMRC so that there is expertise in dealing with the complex issues involved along with an understanding of the bigger picture.
  • The money to fund large parts of the public sector comes from tax revenues and disputes between HMRC and the public sector about VAT can give the impression that vital public resources are being used to fund what appear to be trivial issues.  It is in the interests of all parties to make the system work effectively and deliver good public services and the correct tax results.
  • New rules were introduced in the Finance Act 2015 to extend the scope of the VAT shelter for local authorities to certain organisations – search and rescue,  palliative care charities. The deficiencies in the current approach have led to a situation where organisations are granted the status without a review of the bigger picture

ICAS has concluded that the current VAT regime for the public sector is not effective and does not provide a level playing field and it is time for a review to address VAT complexity and provide a level playing field for all organisations in the public sector.


  • Public sector
  • Tax

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