The recent Court of Appeal decision in the case of Colchester Institute Corporation (‘CIC’), a provider of further education, could have significant implications not only on the the education sector, but on any charity or organisation that relies on grant funding to deliver services.

In litigation that originally started in July 2017 in the First Tier Tribunal, and then the Upper Tribunal in 2022, the Court of Appeal (‘CoA’) has now concluded that the grant funding received by CIC was third party consideration for the supply of education to students. As a result, CIC, which is an eligible body for the purposes of VATA 1994 Sch 9 Grp 6 item 1, was receiving payment for making exempt business supplies.

At first glance this seems a moot point, as there is no output tax due regardless of whether the funding is outside the scope of VAT or exempt, and similarly no entitlement to VAT recovery in either case. However, this marks a fundamental shift: grant funding is now treated as third party consideration, meaning CIC is undertaking exempt business activities rather than non-business activity.

This distinction is significant for several reasons and could potentially affect the wider charity sector, not just colleges providing education.

Background

CIC challenged HMRC’s policy of treating grant-funded education as a non-business activity, because it had recovered all the VAT it incurred on a capital project many years ago under the so called ‘Lennartz mechanism’.

Broadly, this mechanism allowed an organisation to recover all the VAT incurred on a capital project upfront and then to pay an equivalent output tax charge based on the extent of non-business use over the life of the asset. It effectively provided a cash flow benefit.

The output tax charge doesn’t apply in relation to business activities, and it was beneficial for CIC to effectively seek to ‘have its cake and eat it’ by arguing that its activities were no longer non-business but instead were business activities, removing the ongoing output tax charge under Lennartz.

The scope of this benefit to other, similar organisations is limited as the Lennartz mechanism was withdrawn in 2011. However, there are still organisations making residual adjustments as the original ‘life’ of the asset was 10 or 20 years depending on when the project started.

Reasons for the Court of Appeal decision

Before considering the implications of the CoA decision, it is important to highlight why the CoA found in favour of CIC.

In particular, the CoA concluded that it was irrelevant that there was no legal relationship between the recipient and the provider of the funding.

Crucially, when considering the agreements between the parties, the Court found that there was a direct link between the funding and the provision of education. The funding was provided on condition that educational services were supplied to students.

It didn’t matter that the agreements didn’t identify specific students. All that mattered was that CIC was being paid by a third party to deliver certain services. This aligns with earlier tribunal findings that grant funding can constitute consideration where there is a clear link to services provided.

Implications of the decision

The potential implications are wide-ranging and may affect a number of areas:

Revenue and Customs Brief 8 (2021)

Following the the Upper Tier Tribunal decision, HMRC issued a Brief allowing taxpayers to either follow the Tribunal’s decision or continue applying HMRC policy, which treated grant-funded education as non-business.

This allowed organisations to continue benefiting from certain VAT reliefs set out above.

What is next?

HMRC has 28 days from 27 March 2026 to decide whether to appeal to the Supreme Court. If HMRC lodges an appeal, is it unclear whether it will continue to apply the policy set out in Revenue & Customs Brief 8. If HMRC decides not to appeal, then some much needed clarity and guidance is needed from HMRC in relation to the above points.

The current position is unclear, and hence there is little certainty on next steps. However, there is little doubt that there will be a fallout from this judgement with an urgent need for clarity.

For that reason alone, HMRC may well decide to appeal to the Supreme Court to allow for more time to consider the ramifications of the decision further.

Get in touch

If you would like to understand how this decision may affect your organisation, please contact our VAT team to discuss your specific circumstances by filling in the form below.