VAT for Colleges: Upper Tribunal decision on achieving zero-rating for construction work

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Summary of Decision in Wakefield College v The Commissioners for HMRC
This case concerned the meaning of business use of a new building and how income from grant subsidised services should be treated by a charity further education college.  The decision is relevant to all charitable education establishments who teach grant-subsidised students and who wish to qualify for the VAT zero-rate on the construction of a new building.

VAT Background

Colleges are usually unable to recover the VAT on costs they incur.  Hence on a building contract for a new building it will be of importance to a college to achieve zero rating for the construction work and materials.  Under VAT law, to qualify for zero rating the charity must intend to use the building for a relevant charitable purpose "otherwise than in the course or furtherance of a business".

Factual Background

Wakefield College, a charity, undertook the construction of a new building on its campus for the provision of further and higher education.  Construction services were supplied to the College in relation to the building.  The College sought to treat the supply of those services as zero-rated for tax purposes on the basis that the College was a charity and that, as it intended to use the building for the provision of further and higher education, this amounted to a relevant charitable purpose.

In May 2007, HMRC refused to accept the validity of a zero-rated certificate issued by the College to the builder in respect of the construction services on the basis that some of the College's supplies of further and higher education had been made "in the course or furtherance of a business" and therefore not solely for charitable purposes as required by the VAT legislation. 

Zero-Rated Business Test and 5% Rule

VAT legislation provides that construction of buildings intended to be used "solely" for non-business purposes can be zero-rated subject to certain criteria being met.  HMRC will interpret "solely" in such a way as to allow a de minimis amount of up to 5% business use to be disregarded.  Therefore for a charity to take advantage of the charitable purpose VAT zero-rate it must demonstrate that the business percentage fell within the 5% limit.

Treatment of Income Received From Students

The dispute between the College and HMRC has a complicated litigation history but this case was an appeal from the First Tier Tribunal. Both parties accepted that where Wakefield College students were wholly grant funded, that there was no supply in the course of a business. It was also agreed that when students received no grant and paid the full price set by Wakefield College that there was a supply in the course of a business.

The disagreement between the parties focused on whether income received from students who qualified for a reduced grant and who were required to pay a reduced fee should be viewed as business income.

The College argued that it should not, and that use of the new building to educate these students was not business use.  The College's argument was based upon the ECJ Judgment in Commission v Finland (C-246/08).  In the Finnish case, recipients of legal aid were required to make a contribution to costs of their legal representation. The amount they were required to pay was dependent upon their income or assets. The ECJ found that when the legal services were provided by the public legal aid authority, the money paid by the individual was not consideration for a supply. This is because it was not determined with reference to what they were provided with, but rather what the legislation determined they had to pay according to their means. This meant that the public legal aid authority was not required to account for VAT on this income.

Treatment of income received from part fee-paying students

An additional complication was that, within the group of part fee paying students there were several different categories of students paying varying amounts. Some of these students had their partial fees reduced or waived completely or paid a flat rate fee as a result of different personal reasons such as their income or their educational attainments.  The group also included UK students over 19 years of age who were not eligible for further fee remission but nevertheless paid an amount below cost as set by Wakefield College in its prospectus. 

Reduced fees payable due to personal characteristics

The Upper Tribunal ("UT") decided that in respect of those students who had fees rebated due to their low income levels or other personal characteristic factors such as their educational attainments, the link between the education provided and the income received was broken. Therefore, the fee income from those students was not consideration for a supply of education. This was in line with the ECJ decision in the Finnish case.

Reduced fees payable not due to personal characteristics

However, the fees paid by the other students in this group, such as UK students, who were not eligible for any further remission, were consideration for a supply of education.

The fees these students had to pay were set by Wakefield College and had to be paid regardless of their personal circumstances. It was therefore different from the situation in the Finnish case.  On that basis, the UT considered the students payments to be consideration as they were paying an amount in order to obtain educational services. This meant there was a supply and therefore a business activity for VAT purposes.  

The fact that the fees received were below cost, that part of the cost of the course was covered by a grant, and that the UK students above the age of 19 paid less than overseas students was not relevant. Being a UK national was not a personal characteristic of the type set out in the Finland case (e.g. relating to income or assets) and a charge at below cost can still amount to consideration. The link between payment and service was therefore not broken for these partially grant funded and part fee paying students and income received from these students should be considered business income.

Upper Tribunal Decision

The UT ruled that:

  • income received from students who were wholly grant funded should not be considered business income;
  • income received from students who are not grant funded and who paid the full price set by the college should be considered business income;
  • in respect of students who were part-funded, the treatment of income from such students will depend upon the reasons for which a fee reduction is given, in particular:
    • if the reduction was due to personal characteristics of the student (such as their income, assets or educational attainments) - the fee income was not to be considered business income;
    • if the reduction was not due to personal characteristics (for example a fee less than cost for UK students) - the fee income was to be considered business income.

Wider Implications

A similar test for a charity of having to intend the use of a building to be for a "non-business purpose" applies as well as a condition for the zero rating of:

  • the construction of annexe to an existing building
  • the purchase of a new building from the person constructing it.

Potential changes to the VAT system?

The UT judge in his decision expressed some disquiet in respect of the VAT legislation which, in its current form, means that the zero rating is lost in its entirety when a 5% limit is breached. The judge stated that it is unlikely that Parliament intended such a capricious system and suggested that it should be reconsidered.  Only time will tell if this plea is heard by Parliament.