Parents who paid private school fees upfront to avoid price increases due to VAT could be investigated by HMRC, according to tax experts. Paying school fees upfront in private school settings isn't new. In some private schools, parents can choose to pay a lump sum that can act as a deposit for future school years. The school then debits the required amount from the deposit on an annual basis. The benefit to parents is that the school typically offers a small discount in exchange for the upfront payment.
However, figures for 2024 revealed that the top 50 schools held around £515 million in advance fee schemes, an increase from £121 million in 2023. For example, Eton College, where next year's annual fees will reach more than £63,000, recorded around £52 million in its prepayment scheme in 2024. This is up from £16.6 million in 2023.
As a reminder, the Labour government announced its plans to tax private schools as part of its manifesto ahead of the last general election. By taxing the wealthiest families through VAT on private schools, the government hoped to raise around £1.8bn for the public sector. The plans proved controversial, with concerns raised about state schools being inundated by private school students whose parents would no longer be able to afford the fee increases. Despite these concerns, the government pressed ahead with its plans, introducing VAT on most private schools from the 1st of January 2025.
Some parents attempted to avoid the fee increases by paying their school fees upfront. That being said, HMRC's plan to investigate upfront payments isn't new. In fact, it raised the issue in a technical note published in July 2024 where it stated it was aware of an uptick in upfront payments and was prepared to investigate those upfront payments that could still create a tax liability. Several experts at the time warned that the schemes were likely to create a tax liability. As such, the news that HMRC is taking steps to investigate certain upfront payments shouldn't come as a surprise to independent schools.
Which types of upfront payments are likely to be investigated by HMRC?
Certain scenarios could cause a tax liability for parents who made upfront payments to avoid future VAT-related increases. Typically, VAT on services applies when the service is provided; this is when a tax point (the date on which VAT is due on a transaction) is established. However, if a tax invoice is issued before the service is provided, this can be overridden; a tax point is established when the invoice is created. This can, in turn, create different tax liabilities for parents for the same term, depending on when they paid their fees.
The government was aware that parents may use upfront payments to reduce their VAT liability, creating the above scenario. As such, within its draft legislation, it stated that payments made on or after the 29th of July 2024 for the school term starting in January 2025 onwards would be subject to VAT. This is despite the fact that VAT only officially applies to independent schools from the 1st of January 2025. The goal of this policy was to ensure parity between parents who choose to pay multiple years' worth of fees upfront and those for whom doing so is not a viable option. Paying for multiple years upfront could cost hundreds of thousands of pounds.
That being said, many parents paid upfront, well in advance of the 29th of July deadline. Labour's plans to introduce VAT on private schools were in their general election manifesto, and many parents chose not to wait until an official policy announcement, but rather pre-emptively pay their school fees.
But, there are rules in place that suggest that even payments made before the 29th of July could be liable for VAT in some circumstances. Tax rules are complex and prepayment schemes may need to be examined on a case-by-case basis. But, it specifically pointed out that prepayment schemes where parents paid a lump sum in advance, but where the details of what the lump sum was paying for were not determined, could be liable for VAT. This, for example, could include pre-paying for future school years where the exact fees for those school years still haven't been set. This practice is common; parents pay a lump sum as a deposit, and official school fees are set at a later date. As such, many prepayment schemes may be liable for VAT retrospectively.
In its technical note, the government said: "HMRC stands ready to challenge the validity of such payments and will seek to collect VAT on those fees where it is due. Indeed, the government is committed to tackling tax avoidance and, in line with the principle to ensure that the changes are fair and that all users of private schools pay their fair share, HMRC will be carefully scrutinising the detail of these schemes to ensure that schools pay the correct VAT where it is due."
VAT on private schools: What's next?
Government projections suggest that imposing VAT on private schools at the standard rate of 20% will bring in around £1.7bn by the 2029/2030 financial year. Over the long term, it's expected that around 35,000 pupils, or approximately 6% those currently educated in private schools, will join UK state schools as a result of the measure. This is because some private schools will pass VAT costs on to parents, and not all parents will be willing or able to pay the increased fees.
That being said, government estimates suggest that not all schools will raise fees, and those that choose to increase fees will do so by around 10% on average. For context, there has been a 75% increase in average school fees in real terms since 2000, yet private school student numbers have remained steady.
Despite this, the move has proved controversial. Back in June, the High Court dismissed a case brought forward by independent schools and parents of private school students who challenged the government's decision to add VAT to private school fees. Several parents said they'll continue to legally challenge the decision to charge VAT on school fees in light of the judgement.
It's worth noting HMRC has not set a specific deadline by which it will begin its investigation. That said, the government reiterated its commitment to tackling tax avoidance when it introduced its VAT policy, and as such, it's more of a question of when rather than if it will choose to investigate. The decision to investigate and potentially claw back tax on early payments could spark a number of fresh legal challenges.
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