Under section 41 of the UK VAT Act (1994) government departments, devolved administrations, the NHS and Highways England are currently eligible for VAT refunds. As the rules under s41 are complicated for VAT refunds, HM Treasury issued its finalised first draft response paper after consultations in July 2021 with VAT reform proposals it plans to implement.
How does s41 restrict VAT recovery currently?
At present, the organisations listed in Value Added Tax Act (VATA) 1994 s41 have a limited input VAT recovery position restricted to the VAT incurred on the purchase of outsourced services to deliver the organisation’s statutory non-business activities. These outsourced services are known as ‘contracted out services’ (COS).
The contracted-out service rules are complex and burdensome, lengthy and can cause a considerable administrative and financial burden for both the s41 organisations and the suppliers submitting tenders for contracts.
What is the proposal to amend s41 refund model?
The Treasury proposed two alternatives to eliminate the inefficiencies of s41 application:
- scrap the s41 regime ie remove VAT refunds completely
- the full refund model.
The simplification options were to scrap the s41 refund scheme entirely (and have all costs including VAT funded centrally by government), or for outsourced suppliers to zero-rate their supplies to s41 organisations. However, neither of these alternatives was considered by HMT to fulfil the balance of simplification compared to encouraging outsourcing.
Although the removal of s41 would have simplified the VAT system, it would have:
- made the government departments less efficient as they would be choosing to save on VAT costs by carrying out services in-house
- impacted on resource sharing and collaboration amongst government departments.
The full refund model
The Treasury’s preferred proposal of extension of s41, referred to as the ‘Full Refund Model’(FRM), would allow input VAT to be recovered on goods as well as services in relation to the costs of delivering non-business activities.
The FRM would grant the same input VAT recovery position as local government and other organisations listed in VATA 1994 s33 on the purchase of goods and services used for non-business activities, and this would also bring simplification to the VAT recovery position when s41 and s33 organisations worked on joint projects.
Some pros and cons for the FRM were highlighted in the consultations:
- s41 bodies could have a VAT advantage over private sector providers and would have a disincentive to outsource certain services
- FRM would improve fair competition between different suppliers
- FRM involves the considerable widening of the scope for VAT recovery by public bodies: it may become more cost effective to contract third parties to carry out a wider range of services.
Who is affected?
The term ‘government department’ includes the Scottish Administration, the Welsh Assembly Government, a Northern Ireland department, a Northern Ireland health and social services body, any body of persons exercising functions on behalf of a minister of the Crown (each of the following is to be regarded as a body of persons exercising functions on behalf of a minister of the Crown), including any part of a government department (as defined in the foregoing) designated by a direction of the Treasury.
The following organisations are covered in s41 of VAT Act 1994, which will have an impact once these changes are implemented:
- a health service body as defined in s60(7) of the National Health Service and Community Care Act 1990
- an NHS trust established under Part I of that Act or the National Health Service (Scotland) Act 1978
- an NHS foundation trust
- a Primary Care Trust
- a local health board
- a clinical commissioning group
- the Health and Social Care Information Centre
- the National Health Service Commissioning Board
- the National Institute for Health and Care Excellence
- Health Education England (established by the Care Act 2014)
- the Health Research Authority (also established by that Act)
- a strategic highways company appointed under s1 of the Infrastructure Act 2015.
Timing and MTD
HMRC is considering the timeline of making these changes in line with the implementation of Making Tax Digital for government departments, with these departments and NHS trusts using a bespoke system (known as GIANT) to submit VAT returns and additional information to support their VAT refund claims. These bodies are currently deferred from joining Making Tax Digital (MTD) until at least April 2022.
Useful resources
Section 41 VAT ACT 1994