What does Labour’s win mean for independent schools?

12 Jul 2024

The Labour Party’s pledge to apply VAT to fees at independent schools is estimated to generate between £1.3 billion and £1.5 billion in revenue.

This move will significantly impact independent schools, their students, and the wider educational sector.

As of the 2022-23 academic year, the average fee for independent schools was £15,200 per student, in contrast to the £8,000 spent per pupil in state schools.

Since 2010, the funding gap between independent and state schools has more than doubled, prompting Labour to advocate for change to redistribute educational funding more equitably.

The proposed VAT on school fees, likely to be introduced from 1 April 2025, aims to enhance the public school system by using the additional funds to raise educational standards.

However, this could also make independent education less accessible due to increased costs, potentially decreasing enrolment and straining the financial viability of some schools.

Financial impact on schools

Currently, independent schools benefit from a VAT exemption on educational services, allowing them to operate without adding VAT to their fees and without the ability to reclaim VAT on their expenses.

Removing this exemption could increase education costs significantly if Labour applies the standard 20 per cent VAT rate.

The Institute for Fiscal Studies suggests that the effective VAT rate might be around 15 per cent after accounting for various deductions.

This increase could make private education unaffordable for more families and particularly affect smaller schools with narrow operating margins.

Economic and Demographic Considerations

While the VAT is expected to bring in substantial revenue, economic analyses provide mixed views on its net benefit to government finances.

If significant numbers of private students move into the state system due to fee increases, the government may face higher costs than anticipated.

For example, a 2018 report suggested that transferring a student from an independent to a state school could cost the Government an additional £10,000 annually.

Moreover, the Adam Smith Institute argues that the removal of VAT exemptions could lead to a net revenue loss of up to £1.6 billion.

Managing the transition

When implemented, the introduction of VAT on school fees will require careful management to mitigate negative impacts on students and schools.

Independent schools could consider advanced fee collection to maintain VAT exemption for certain periods.

We are certainly aware of several schools already applying this methodology, whereby a lump sum payment is taken in advance of the change coming into place to avoid the additional costs that will need to be imposed due to VAT.

Typically, in exchange for a one-time payment made upon or following the acceptance of a student’s placement offer, a school will provide a credit that will be applied against future tuition fees.

While this approach is certainly appealing, it isn’t without its challenges. For example, this strategy might be limited by anti-forestalling legislation, which could see monies recovered from schools.

Challenges of implementing an advance fee collection service

When implementing a scheme for fees paid in advance, careful management is essential. The discount rate offered should be balanced so that the school does not incur financial losses from these transactions.

While such schemes can be beneficial for improving cash flow and appealing to parents, they carry inherent risks.

The collected funds must remain accessible to meet ongoing operational needs without compromising the school’s financial stability.

Significant prepayments could also introduce heightened risks, such as potential money laundering concerns or financial losses to parents should the school close unexpectedly.

If VAT is extended to educational services, you might still maintain VAT exemption for specific services like childcare by structuring them under separate contracts with distinct fees.

Consider setting up a separate legal entity to manage these exempt services, such as residential boarding or after-school care. This separation could provide clarity and maintain exemptions where applicable.

Looking Ahead

Independent schools should consider financial strategies to mitigate the impact of VAT introduction and explore maintaining some exemptions through separate contracts for specific services, such as childcare.

The introduction of VAT on independent school fees represents a significant shift that could reshape the financial landscape of private education in the UK, so if you need advice please speak to our team.