NHS could face £500m bill over VAT changes, experts warn

Tax advisors have told HSJ that changes introduced to VAT recovery rules for certain contracted out services – including administrative agency staff, estates maintenance, and professional services including consultancy – could mean NHS organisations face substantial increased costs.

An analysis by auditors Ernst & Young found that the loss of this recoverable VAT could cost the NHS upwards of £500m.

The changes apply to a number of VAT recovery mechanisms contained in the Contracted Out Services Provisions, which were introduced in the 1980s to encourage public sector bodies to outsource services. HMRC said the new guidance it was asking trusts to follow from 1 April introduced no changes, and that trusts had previously “misunderstood” the VAT recovery rules.

An HMRC letter sent to NHS organisations in February regarding VAT recovery on agency staff states: “We are aware that as a result of the term ‘agency staff’ being included within the heading many NHS bodies have recovered VAT incorrectly on supplies of agency staff, rather than under a contract for the provision of services.”

It continues: “Where agency staff have been utilised because of difficulties in recruiting staff to fill permanent posts or are brought in to supplement existing staff levels during busy periods, then the criterion of being a contracted out service would not be satisfied and consequently any VAT incurred would not be recoverable. Hiring staff to continue an in-house activity is the opposite of contracting out that activity.”

This does not apply to agency nursing staff, where VAT can still be recovered.

Audrey Fearing, a partner at Ernst & Young’s indirect tax team said: “From our perspective the NHS has been applying the Contracted Out Services [COS] provisions correctly and HMRC has either explicitly or implicitly agreed to this over many years.”

Ernst & Young’s analysis looked at the amount of VAT recovered previously by its NHS clients under the main categories of contracted out work covered by HMRC’s new guidance. They found that for a trust with less than £200m turnover the cost would be around £1m. For a trust with a turnover above £750m the cost could be £4m.

Andrew Armitage, managing director of financial consultancy Liaison said: “HMRC introducing these and other changes from 1 April means that NHS bodies will have already set their budgets for the coming year and this leaves them no time to adapt and could effectively increase costs by 20 per cent in several areas.”

An HMRC spokesman said that since the VAT recovery rules did not apply to all purchases “it can be open to interpretation in some areas so to help NHS bodies we have made available the guidance notes issued to departments in 2012 - asking for these to be applied from 1 April”. Previously, NHS providers were following the NHS VAT guidance from 2005.