For organisations that receive public funding for specific purposes, including academies and colleges, the VAT scope of that funding matters.
The Court of Appeal has recently weighed in via its recent decision in HMRC v Colchester Institute Corporation [2026] EWCA Civ 363 – showing how the agreement between organisation and funder is key.
Background
Colchester Institute (“CI”) provides education to both paying and non-paying students. During the period in question, CI received funding from the UK Government to cover the provision of education to the non-paying students.
If a body, whether a not-for-profit body or a for-profit-body (“Body”), receives public funding and is required to do something with that funding, then either:
- The funding is consideration for a supply (within the scope of VAT); or
- The funding goes towards the general funds of the Body and the funding should usually form part of the Body’s non-business income (outside the scope of VAT).
Given that the Government will invariably attach some conditions to the provision of public funds, the question that arises repeatedly is: does fulfilling those conditions amount to a “supply” to which the funding is directly linked (bringing the funding within the scope of VAT)?
Court of Appeal decision
In the analysis by the Court of Appeal (“CA”), the agreement between CI and the funding agencies was critical.
HMRC had argued that, in respect of non-paying students, CI was performing non-business activities because the students did not provide consideration in return for their education. CI argued that it did receive consideration in return for providing education services – it just received this consideration from the Government instead of directly from the students themselves. It was not in dispute that if CI received consideration in return for its supplies, then such supplies were VAT exempt supplies of education services in CI’s case.
Relevance of the decision
The implications of the CA decision in HMRC v CI are of general relevance to any Body receiving public funding.
From a technical perspective, the case of CI itself is a long-running saga which involves a highly specific fact pattern of the timing of input VAT claimed via the Lennartz mechanism.
In detail: grounds of appeal and the responses
HMRC brought the appeal on two grounds. HMRC won on Ground 1 and lost on Ground 2. Because of the significance of the decision for publicly funded bodies, it’s worth exploring these grounds and the Court’s responses in detail, including two of the Court of Justice of the European Union (“CJEU”) cases that were cited.
We consider Ground 2 first as this is the more generally applicable part of the decision.
Ground 2
The CA found the agreement between CI and the funding agencies (“Agreement”) to be of particular importance when considering whether CI was making supplies within the scope of VAT to its non-paying students.
HMRC argued that there was no direct link between the funding received and the services provided.
The CA found that the following clauses of the Agreement with one of the funding agencies were of particular relevance:
- CI was required to “…provide the Services”
- CI was required to use the funding “solely for the purpose of delivering the Services”
- “In consideration of [CI’s] performance of its obligations… the EFA shall pay to [CI] the Funds…”
The CA also found it supportive of CI’s position that CI provided the same services to paying and non-paying students alike. There was no argument that CI’s supplies to paying students were outside the scope of VAT.
On this basis, the Court held that there was a sufficiently direct link between the funding received and the services provided to bring the supplies of education services within the scope of VAT.
HMRC’s arguments on Ground 2
Below are some of the arguments made by HMRC against there being a sufficiently direct link, and the reasons the CA gave for upholding the Upper Tribunal (“UT”) decision that a direct link existed between the funding and CI’s supplies of services.
Autonomy
HMRC argued that CI had too much autonomy over which courses to provide to which student. The point here seems to be that the funding does not relate to any particular course if it is at the supplier’s discretion which course to provide.
The CA responded that the funding was determined based upon formulae that sought to reflect those choices.
Identity
The identity of the student was unknown at the time of the funding being provided. HMRC had argued that this was a different scenario from the facts considered by the CJEU in Rayon D’Or (as described below).
The CA responded that at the point of funding, the identity of residents in Rayon D’Or was also not necessarily known and that, anyway, there “were criteria which defined those who would benefit.”
Price estimate
The number and type of courses actually provided by CI was not known at the time of the funding and therefore the consideration payable for each specific supply of education services to each specific student was not known at the time.
The CA maintained that this was analogous to a price estimate scenario where the price might not be known at the time of the agreement but was “capable of being ascertained.”
Legal relationship
HMRC argued that the direct link was broken by the fact that the funding agencies didn’t have a legal relationship with the students (and, again, that the facts in HMRC v CI didn’t align with the facts in Rayon D’Or).
The CA disagreed that this could break the direct link between funding and the service supplied, since the concept of third-party consideration does not require “a legal relationship between the payer and the recipient” for a direct link between payment and supplies to exist.
Ground 1
On Ground 1 of the appeal, the CA did hold that the UT had gone too far when it said that the case of Rayon D’Or concerned a completely different type of supply to a “Kennemer” supply and that the CI supplies were indistinguishable from those in Rayon D’Or.
This Ground was not necessary for the CA to find in favour of CI, since HMRC would have had to win on both grounds in order to be successful.
CJEU case (C-174/00) – Kennemer Golf and Country Club v Staatssectraris van Financien (“Kennemer”)
This case concerned the supply of facilities by a golf club to its members – specifically, to those members of the club who did not actually use the facilities.
The CJEU held that the fixed sum which comprised the membership fees could not be linked to any particular member’s use of those facilities. The services supplied by the golf club consisted of “the making available, to its members, on a permanent basis, of sports facilities…”. This is what provided the direct link between payment and the services (including members who did not use those facilities).
CJEU case (C-151/13) – Rayon D’Or Sarl v Minstre de l’Economie et des Finances (“Rayon D’Or”)
The French state provided a lump-sum payment to a care home in respect of healthcare services that the care home provided to its residents. The lump sum was calculated on the basis of a daily rate for accommodation, dependency and care. It took account of the number of residents, although the decision appears to have related specifically to the healthcare element.
It was discussed that the level of healthcare may differ from resident to resident (depending on their personal needs). Rayon D’Or argued that since the actual healthcare services provided were not specified in advance – how could they be? – there was no direct link between the lump sum and the services actually provided.
The CJEU held that the supply of services by Rayon D’Or was characterised by the “permanent availability of the service provider to supply, at the appropriate time, the healthcare services required by the residents”, and that it was not necessary for a direct link to exist “to establish that a payment relates to a personalised supply of healthcare at a specific time carried out at the request of a resident.”
In summary:
- Kennemer related to the making available of facilities to its members on a permanent basis
- Rayon D’Or stretched this to include the making available of services to its residents to be used if and when its residents required them
The CA’s responses on Ground 1
According to the CA, the UT erred in holding:
- That Rayon D’Or did not concern Kennemer supplies at all and created a new type of supply.
- That CI’s supplies (the provision of education) were, for VAT purposes, indistinguishable from the supplies in Rayon D’Or (making available of healthcare supplies). The CA held that there were points of distinction. While not clearly reiterating these, the points of distinction appeared to be that: (i) Rayon D’Or had a Kennemer-type permanent availability feature whereas CI concerned an actual supply; (ii) there was a relationship between insurer/insured (payer and recipient, respectively) in Rayon D’Or; and (iii) there was an identifiable class of beneficiaries in Rayon D’Or.
Rayon D’Or was not decisive on its own for CI to succeed, but the CA upheld the decision of the UT insofar as there was a direct link between the funding received by CI and the services supplied by CI.
Key insight: use appropriate wording in funding agreements
The CA decision in HMRC v CI reiterates an important point: properly drafted funding agreements will often be critical to the question of whether funding represents consideration within the scope of VAT, or non-business income outside the scope of VAT. This assumes, of course, that those agreements reflect the economic reality of the agreement between the funding agency and the recipient of funds.
How we can help
The BKL VAT team can help ensure that your legal documents, including funding agreements, stand up from a VAT perspective and are optimally-worded to avoid misunderstandings with HMRC. We support our specialist academies & schools team in guiding academy trusts through the complex VAT situations they may encounter.
For a chat about how we can help you, contact your usual BKL contact or use the form at the bottom of the page.
