VAT reforms make sense, but mitigations needed

NHS bodies currently cannot recover VAT paid in delivering most non-business activities, which covers their core delivery of healthcare. VAT is a cost to the service and NHS allocations take account of this. However they can recover the VAT incurred on a limited list of services, covered by section 41 of the VAT Act 1994.

The services eligible for this special treatment are set out in contracted-out services (COS) directions, published by the Treasury. The aim was to stop VAT being a distortive factor when deciding if a service should be provided in-house (not subject to VAT) or outsourced (which without section 41 would be subject to VAT).

However, the Treasury recognises that ‘section 41 in its current form is unduly complex, administratively burdensome and a barrier to effective financial planning’. Its proposed solution – set out in an August discussion paper - is to move to a full refund model – extending the scope of section 41 to permit full refunds of the VAT incurred on all goods and services during the course of non-business activities.

The changes would need to be fiscally neutral, so the departmental expenditure limit would be reduced to reflect that fact that VAT would no longer be a cost for departments or NHS bodies.

In response to the Treasury’s consultation on the proposals, the HFMA said the current COS system was both complex and not fit for purpose. ‘The time and effort required by NHS staff, consultants and HM Revenue and Customs to effectively operate the system and interpret the guidance has raised questions by many individuals for many years,’ it said. A simpler VAT recovery system would be a ‘positive development’ and its introduction supported by the NHS finance function.

But, with ramifications for the NHS and contractors, it warned that it would need careful planning and implementation and mitigating measures would be needed.

While the HFMA agrees that the changes will need to be fiscally neutral, it has insisted that this neutrality should flow through the system. Alternatively, the impact of the change on an individual body’s financial position would need to be recognised as outside its control.

A trust’s VAT efficiency will depend on a number of issues, including: whether it has a private finance initiative scheme; the number and size of any subsidiaries; and the number of managed service contracts it has.

Early assessments by some organisations suggest the impact could be as high as £14m. ‘It is vitally important that the impact of moving to the full recovery model is considered at the NHS body level as well as the departmental level,’ the HFMA response said. Foundation trusts, which have the ability to set up subsidiaries, may be particularly affected and would want any benefit secured by setting up the subsidiary carry on under the new rules.

Timing will be another key issue. Although the Treasury has not indicated when any proposals might come into force, the HFMA said that finance managers would need at least one planning round to implement the changes. ‘This would mean that if the changes were included in the April 2023 Finance Bill then the date of implementation would need to be 1 April 2024 at the earliest as the planning for 2024/25 would start in the autumn of 2023,’ the association said.

Transitional arrangements might also be needed to prevent incentives being created to delay purchases around the date of implementation.

Read the HFMA’s full response