VAT, the Big Society and community outsourcing

A significant issue has recently come to light in respect of the Big Society agenda and its interaction with VAT. Jack Hayward explains how it impacts on the cost viability of community outsourcing.

Under Section 33 of the VAT Act 1994, local authorities are permitted to fully recover VAT incurred where this is in connection with their non-business activities, notably ‘free at the point of delivery’ public services, such as primary and secondary education, most social care, including adult social care and childcare, public libraries, waste collection etc., and/or their VAT-exempt business activities, notably the letting of premises and the provision of fee-paying education, providing such exempt-attributable VAT is insignificant (generally considered by HMRC to mean less than 5% of all VAT incurred).

On the other hand private sector bodies drawn into the public service delivery regime by the Big Society – including those created under the Localism Bill legislation or as a result of the Open Public Services White Paper – will be subject to normal VAT rules, i.e. VAT incurred in connection with non-business activities including non-income generating activities will normally be irrecoverable as is exempt-attributable VAT except for some limited exceptions.

Therefore the outsourcing of public services has the potential to increase the cost of those public services by 20%, being the irrecoverable VAT consequently incurred. This will probably be particularly relevant in the delivery of the individual and neighbourhood services envisaged in the Open Public Services White Paper.

The bulk of welfare and health care is exempt from VAT and this will probably take care of the issues around the delivery of services under the individual budget arrangements. Likewise  ‘neighbourhood services’, to the extent these are delivered by the town, parish or community council (including by newly created town, parish or community or neighbourhood councils) these bodies are local authorities for VAT purposes and so covered by Section 33.

In the context of ‘commissioned services’ and what might be termed ‘commercial outsourcing’, the issue is whether such creates a ‘hidden’ irrecoverable VAT cost.

This is the case where the ‘commissioned services’ are exempt from VAT, such as welfare or healthcare. If a local authority uses third sector providers to deliver such ‘commissioned services’ on their behalf, whilst the supply to the commissioning local authority may be exempt from VAT, the consequence of this is that VAT incurred by the provider in connection with delivering the service is exempt-attributable and so irrecoverable.

Where ‘neighbourhood services’ are outsourced to entities such as voluntary groups, community associations, social enterprises and mutuals, these do not benefit from Section 33 status but are subject to the full rigour of the VAT rules. Consequently these providers of ‘neighbourhood services’ will incur VAT on both infrastructure and day-to-day running costs in connection with their delivery of the outsourced services of which in most cases only a fraction will be recoverable. Therefore, in effect, potentially increasing the cost of the outsourced services by 20%.

This is because free community activities, i.e. activities for which no express payment is received, are non-business and VAT is only recoverable where incurred in connection with VAT incurring business activities even where express payment is received. Many sources of income for such ‘neighbourhood services’ are likely to be exempt from VAT, eg room lettings and the provision of education and sports facilities, and exempt-attributable VAT is similarly generally irrecoverable. An example could be the finances of a Community owned building which delivers local services and rents out spare rooms to community groups. Any costs from plumbers or the supply of stationery will attract 20% VAT at the point of supply. This VAT will be irrecoverable and the VAT incurred passed on to the users of the facility. Over 12 months this 20% may add up to a considerable sum.

In the majority of cases it is probable that community groups taking over neighbourhood services will not be registered for VAT and VAT incurred by a non-registered entity is irrecoverable.

Recently the Government has created Section 33B in order to permit academies to recover VAT incurred in connection with their delivery of free statutory education as a non-business activity and to ensure that academies are treated equitably with local authority schools having the benefit of their ‘parent’ local authority’s Section 33 status. However the EU Commission is not happy with this approach and takes the stance that such refunding of VAT incurred other than in connection with VAT incurring business activities are not permitted. The Government’s response has been that such public funding refund mechanisms are not VAT law and so not within the Commission’s remit! Either way it seems that the matter is not yet settled and the VAT issue is another hurdle to be addressed in the implementation of the Big Society agenda.

Jack Hayward is a consultant procurement solicitor and editor of the Public Procurement Page. and can be contacted at This email address is being protected from spambots. You need JavaScript enabled to view it..