9 April 2026
Funding or fee? Court of Appeal confirms when public grants are taxable consideration for VAT
Colchester Institute Corporation (CIC) provides VAT exempt education and services. Many of its students pay no fees because their education is funded by public bodies, principally the Education Funding Agency and the Skills Funding Agency.
HMRC assessed VAT on the basis that, where teaching was government funded, CIC made no supplies for consideration and was instead carrying on non business activities, with the funding treated as general subsidy to support CIC’s activities, lacking a sufficiently direct link to supplies of education, and therefore outside the scope of VAT.
The non-business characterisation (as opposed to VAT exempt characterisation) mattered because HMRC used it to raise deemed output tax under the non business (Lennartz) rules, on the footing that CIC had over recovered input VAT on assets and overheads used for funded teaching. CIC appealed, arguing that it supplied VAT exempt education to identifiable students and that the funding constituted third party consideration paid in return for those supplies. Therefore, deemed output tax assessed under the non business rules would not arise.
The Court of Appeal upheld CIC’s position. Examining the funding agreements, it found clear reciprocity: payments were made in return for delivering approved courses to eligible students, supported by learner level reporting, output based funding formulae and clawback mechanisms. Those features were sufficient to establish a “direct link”, even though funding was calculated by proxies and not per student. Once the activity was correctly characterised as business (albeit exempt), the legal basis for HMRC’s non business output tax assessment fell away.
Key takeaway
This is an important judgment for those dealing with VAT in the education sector or sector where services are publicly funded. The judgment confirms that publicly funded services can still be supplied “for consideration”. Businesses receiving grants or subsidies should review funding terms carefully: where payments are linked to defined outputs or beneficiaries, VATable supplies may arise even if no fee is charged to end users.