In recent years, Keir Starmer has significantly fanned the flames of the debate about charitable status for independent schools, with his Labour Party pledge to remove tax concessions for independent schools in a bid to raise funds for state education. The issue is not new, but there is no doubt that those involved in the sector will be feeling the heat as the debate rages on.
In January, Labour put forward a motion calling for the select committee to look at reforming the charitable and tax status of independent schools, which was defeated (303 votes to 197) following a heated debate in the House of Commons. But this is not the end of the issue, and much has been written about the potential implications for the education sector should Labour be successful in the next general election and make good on its pledge. On 14 June, the House of Commons published a research briefing on the charitable and tax status of independent schools and the recent political debate on whether reform is needed.
There is uncertainty about how much tax revenue the proposals would actually raise, given that many of the families whose children currently attend independent schools would be forced to withdraw them due to the resulting increase in fees. This raises obvious concerns about how the state school sector would cope and the potential consequential impact on the most vulnerable in society. On the other hand, advocates of the proposals argue that it is an important step in 'levelling the playing field' in education and providing equal opportunities to all children, regardless of socio-economic status.
For those of us who are parents, the issues transcend political views and ideologies: the proposals will affect all children – whether state or privately educated – and that makes it deeply personal. We all have skin in this game.
It is not yet clear exactly how the Labour Party proposes to give effect to its proposals. As such, it is not possible to comment on specific implications. However, setting aside the political debate, as a charity lawyer who has many years of experience advising both independent schools and academy trusts on a day-to-day basis, in this article I consider the potential legal implications of the proposals, and explore some potential solutions for independent schools should the proposals become reality.
What are Labour's proposals for independent schools?
Labour has pledged to remove charitable status from independent schools, which would have a significant impact on their tax status. As charities, independent schools do not pay tax on annual profits (which, instead, must be reinvested for the advancement of education for the public benefit). They also benefit from charitable business rates relief, Gift Aid on donations and a range of other tax advantages.
In addition, Labour has pledged to remove the VAT exemption on school fees. This is not an issue that is linked to charitable status: the relevant VAT exemption is one that applies to all organisations providing eligible educational services, whether or not charitable. If the VAT exemption were to be removed, this would force independent schools to charge VAT on school fees, costing parents of students at those schools an additional 20%.
The financial implications for independent schools, if some or all of these proposals are pushed through, cannot be overstated. Whilst the press routinely focuses on the most elite independent schools, there are over 2,600 independent schools in the UK, approximately half of which are charities. The vast majority of independent schools are relatively small (fewer than 300 pupils) and do not benefit from substantial endowments. The increase in running costs would necessitate higher fees, on which a further 20% VAT would be payable. As pupil numbers inevitably reduce with rising costs, the issues would be compounded. So, Labour's pledge is – quite understandably – causing a great deal of concern for Bursars at independent schools, whose job it is to make ends meet.
The threat to charitable status
The Charities Act 2011 defines what we mean by 'charity' as a matter of law in England and Wales, and the definition is based in purpose.
An institution established for exclusively charitable purposes is, by legal definition, a 'charity'. The law defines 'charitable purpose' as a purpose that falls within the list of purposes set out in s3 of the Charities Act 2011, which is carried out 'for the public benefit'.
The public benefit requirement is at the root of the debate about charitable status for fee-charging independent schools. In particular, the requirement for there to be an identifiable benefit (or benefits) made available to a 'sufficient section' of the public, will not be satisfied if 'the poor' are excluded from benefitting.
In The independent schools Council v. The Charity Commission [2011] UKUT 421 (TCC) the court ruled that the Charity Commission could not be prescriptive as to how independent schools should make provision for 'the poor' to benefit:
"It is not possible to be prescriptive about the nature of the benefits which a school must provide to the poor nor the extent of them. It is for the charity trustees of the school concerned to address and assess how their obligations might best be fulfilled in the context of their own particular circumstances."
The mere fact that 'the rich' may benefit from a charity's activities does not mean that an institution is not a charity. This has been confirmed recently by the Supreme Court in Nuffield Health v London Borough of Merton Council [2023] UKSC 18, where Lord Briggs and Lord Sales states that "the "scope" element of the public benefit requirement is satisfied by reference to the whole of the section of the public thereby benefitted, rich and poor alike". (See our recent article for more on this particular case).
Under current law, provided that independent schools can demonstrate that they make provision for those of 'modest means' to attend (this is usually achieved through the provision of scholarships and bursaries) they generally satisfy the public benefit requirement and therefore are recognised as charities as a matter of law.
Due to the legal definition of 'charity' under current law, for independent schools to lose their charitable status it would be necessary for new legislation to be passed. Regardless of whether the proposal is to entirely exclude fee-charging independent schools from the legal definition of 'charity' or to change the way in which the public benefit requirement is applied to fee-charging independent schools, legislation would be required.
Introducing new legislation for this purpose would involve the usual passage through Parliament, which includes approval by the House of Lords. There has already been some debate in the House of Lords in relation to this issue during the Lords committee stage of the Schools Bill, when a proposed amendment to exclude independent schools from charitable tax reliefs was debated. The proposed amendment was withdrawn following debate, and it is far from clear that there is a consensus on this issue within the House of Lords.
Whilst it is true that even if there were opposition from the House of Lords, the House of Commons could eventually push a Bill through, my view is that it is unlikely to be at all straightforward for any changes in legislation to be made that would have the effect of stripping charitable status from independent schools. Not only does the issue itself divide opinion in both Houses of Parliament, but it would also be a complex matter to consider the wider implications for the charity sector arising from any statutory changes to the legal definition of 'charity'.
The concept of 'public benefit' is not defined by statute, and the law in this area has developed incrementally over several centuries of case law. There have also been different applications of the requirement to different categories of charitable purpose, which paints an even more complex legal picture. For this reason, it would be extraordinarily difficult to create a statutory definition of 'public benefit' without risking significant unintended consequences for the wider charity sector.
The threat to charitable tax reliefs and VAT exemption
There are many tax advantages that are directly related to charitable status. These include relief on income tax and inheritance tax, Gift Aid on donations, mandatory 80% business rates relief on premises used in furtherance of their charitable purposes (plus up to 20% additional discretionary relief), relief on stamp duty land tax and a number of specific VAT reliefs.
Independent schools are also exempt from the requirement to charge VAT on school fees because the provision of education by an 'eligible body' is an 'exempt' supply for VAT purposes under current VAT legislation.
If no legislative changes are made to strip independent schools of their charitable status, it would be necessary to introduce a range of legislative changes to deprive charitable independent schools of the tax advantages they currently enjoy. However, this could be achieved much more swiftly than implementing legislation regarding charitable status, due to the 'financial privilege' that the House of Commons has in respect of so-called 'Money Bills'.
Scotland has set a precedent in this regard, having already passed legislation to expressly exclude mainstream fee-paying independent schools from being eligible for mandatory business rates relief that is available generally to charities (which was implemented in April 2022). In theory, similar legislative changes could be made in England and Wales to expressly exclude fee-paying independent schools from specific tax reliefs without removing their charitable status entirely.
Whilst theoretically possible, concerns have been raised (in particular by the Charity Finance Group) about the unintended consequences and the creation of a "two-tier" system of charities if independent schools were to retain their charitable status, yet be stripped of certain tax benefits through targeted legislation. The Charity Finance Group's clear view is that "all charity tax reliefs should apply equally to all organisations which are recognised as being charities" and that "charitable status should be determined by charity law and not by the tax system".
What are the potential solutions for independent schools?
It is very difficult to consider solutions until more information is made available about the specific proposals. We would not recommend implementing any changes or taking steps to restructure purely in response to the Labour Party pledge at this stage. However, many independent schools are seeking tax advice now in order to understand the potential financial exposure and potential means of mitigation. There are a number of potential solutions, all of which would involve restructuring to some extent.
Some independent schools might consider converting to academy status. Academies are also classed as 'independent', but they are publicly funded and benefit from charitable status and all associated tax reliefs. A small number of independent schools have already converted over the years, but the process is not entirely straightforward and there have been calls for the DfE to make it easier. This option would, of course, involve a significant change to the regulatory and financial framework within which the school operates. It would no longer be a fee-charging independent school and it would become subject to all of the additional regulation imposed on academy trusts by the DfE, in addition to charity law compliance.
For independent schools that are not interested in becoming academies, if charitable status were removed it would be necessary to make various governance changes (for example, changes would be required to the governing documents), and to entirely reconsider business operations from a tax perspective. For example, collapsing trading subsidiary structures or setting up new separate charities (which are still eligible for charitable tax reliefs) and hiving out certain assets into them.
If the current VAT exemption on school fees were to be removed, changes would be required to the Parent Contract, and some independent schools might wish to consider either introducing or making use of an existing Fees in Advance Scheme to facilitate payment of fees before any change in VAT rules comes into effect. This would not, of course, be universally affordable and there are risks that would need careful consideration. Any restructuring or changes to mitigate the impact of the loss of VAT exemption on school fees would need to be very carefully considered and we would recommend seeking expert advice from an experienced VAT specialist.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
