Accounting

A matter of VAT

Many schools set up their own trading companies for a variety of purposes. But, according to Steve Hodgetts, it is important to review them as they may not be the appropriate means to achieve the school’s original aims

Independent schools have historically channelled their trading activities through a subsidiary company, given the direct tax limits on trading outside their charitable objects and the restrictions placed on trustees.

The premise of setting up a trading company is that it will gift aid profits back to the school in order to avoid any exposure to corporation tax.

Yet many trading companies are superfluous as the income streams which are routed through the company actually satisfy the school’s charitable objectives, perhaps because the goods or services supplied are ancillary to the primary purpose of the school.

The trading company may have been created to enjoy a VAT benefit, for example via a lease and leaseback structure; or it may have been believed that a trading company was more VAT-efficient as it was not an “eligible body” for the purpose of providing education or sporting services.

Take care
Careful consideration should always be given to the use of a trading company. The income received by the company may create an unnecessary exposure to register for VAT because the school may not recognise that the VAT liability of income may be different for the company. This is largely because the VAT exemptions enjoyed by schools apply to “eligible bodies”. The trading company is unlikely to satisfy this definition because it is free to distribute its profits, whereas the school is not.

Of course, the opposite can also occur when a trading company incorrectly accounts for VAT on its income, not realising a VAT exemption applies.

Giving rights
In many cases, schools grant rights to trading companies; for example, a right to use the school’s buildings, often without payment and with little documentation to support the arrangements. There are cases where HM Revenue and Customs (HMRC) has argued that the services are actually being provided by the school, although the income is routed through the trading company. This may nullify the original rationale for the use of the trading company.

Furthermore, the use of a trading company may require the school to notify HMRC that it is operating a listed avoidance scheme. This is because the VAT liability of trading education provided by a trading company would normally be taxable, whereas education provided by the school is exempt from VAT. Following formal disclosure, HMRC would normally wish to examine the arrangements to determine whether the structure creates the desired VAT outcome for the school. A disclosure may also be required for any long-standing lease and leaseback arrangements that still exist.

Careful what you claim
The use of a trading company can also create difficulties for schools wishing to claim VAT reliefs. For example, the construction of a new boarding house is wholly relieved of VAT if it is used by the school for a “relevant residential purpose”. The building must be used by the school solely for this purpose for a period of 10 years. It is a misconception that any incidental non-qualifying use of the building will not threaten the VAT relief originally claimed on the construction of the building. For example, use by the trading company of the boarding house for the provision of summer lettings may jeopardise this VAT relief, creating a substantial VAT cost to the school.

Although a trading company creates VAT risks, it can also create several VAT opportunities. At the most basic level, the use of a trading company can protect the school from a liability to register for VAT. A trading company is also able to recover VAT on expenditure if it is making taxable charges, perhaps to members of the community wishing to use the school facilities. Consequently, a trading company may well achieve VAT savings if, for example, the school is constructing a sports facility or a theatre and incurring large amounts of VAT.

The bigger picture
Schools should also consider whether a trading company will improve the school’s overall level of input VAT recovery by registering together with the school as a VAT group.

Schools operating trading companies for several years should review their merits.

Steve Hodgetts is a VAT partner for Baker Tilly. 

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