Court of Appeal judges have ruled in favour of Colchester Institute in a landmark VAT dispute with HMRC, paving the way for colleges to reclaim tax on pre-2010 building projects.
The government tax authority has been locked in a dispute with the Essex college since the 2010s over what tax discounts it can claim on a large building project.
Judges in the lower tax courts, the High Court and now the Court of Appeal, the second most senior in England and Wales, have repeatedly ruled in favour of Colchester Institute.
The ruling means Colchester Institute, and an estimated 20 to 30 colleges with similar claims, should now be able to reclaim VAT payments made on capital projects started before 2010 that will be used for teaching a mix of fully-funded and fee-paying students.
However, it has also extended a state of uncertainty, as the colleges – and potentially charities – could permanently lose large VAT discounts for charitable organisations.
An HMRC spokesperson told FE Week: “We note the decision and are carefully considering our next steps.” It has until April 24 to decide whether to apply to appeal to the Supreme Court.
After it first lost the dispute in the Upper Tax Tribunal in 2020, HMRC took the rare step of telling colleges they could effectively ignore the ruling – despite the court decision setting a binding legal precedent – while its lawyers mounted a “test” appeal in the High Court.
Colleges known to have similar claims to Colchester Institute include Portsmouth College, Cornwall College, and Derby College Group.
The disagreement centres on a series of VAT claims Colchester Institute made on a large building project started in 2008, using a rule known as the ‘Lennartz mechanism’.
The Upper Tax Tribunal agreed, ruling that the college’s grant-funded education should be treated as a “business activity” for VAT purposes, rather than a “non-business activity”.
However, this classification change excludes colleges from being able to claim VAT reliefs, which could result in some colleges having to pay millions more in tax.
Reliefs include a zero-VAT rate for new-build construction projects and five per cent tax rates on fuel and power costs.
Colchester Institute’s victory has also been described as a “one-off”, as HMRC withdrew permission for colleges to use the Lennartz mechanism in 2010.
Socrates Socratous, VAT adviser at accountancy firm Buzzacott, told FE Week that if the ruling stands, it could be a “problem” for colleges currently constructing brand new buildings that could lose VAT reliefs.
He said HMRC should issue new guidance for the college and charity sector clarifying what its position is.
Socratous added: “This decision is good for Colchester Institute, but the implication goes beyond just colleges.
“It’s something that might affect the charity sector generally, to its detriment, and I think that’s why HMRC needs to take a step back and think about what they’re going to do.”
Noel Tyler, executive chairman of VATangles, which advises Colchester Institute, said: “There was always, to me anyway, a clear and obvious disconnect between HMRC’s longstanding policy and binding case law with regards to the fundamental question of what is, and what is not, for VAT purposes, a ‘business activity’.
“Indeed, HMRC’s policy on the matter is entirely friendless in law, and yet they persist with it, and not just in respect of FE colleges.
“They have actually been quite aggressive with colleges who have applied the binding law.
“However, the Court of Appeal has had no apparent difficulty in, yet again, rejecting HMRC’s arguments. It will be interesting to see where they go now.”
Colchester Institute said: “The college does not comment on matters where there might be further legal implication.”
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