In March 2026, the Court of Appeal released its judgment in the VAT case concerning Colchester Institute Corporation (CIC), bringing the long running uncertainty over the VAT treatment of public funding for further education (FE) institutions to a head. HMRC has released an interim response in Revenue and Customs Brief 3 (2026).
What did the Court decide?
Although the core issue in this VAT case concerned the repayment of output tax previously accounted for under the Lennartz mechanism, the biggest impact to the charity sector is that the Court of Appeal ultimately upheld the earlier Upper Tribunal decision that funding received by CIC from public bodies constituted consideration for a supply of VAT-exempt education rather than non-business grant funding.
HMRC’s policy response
In Revenue and Customs Brief 3 (2026), HMRC confirmed that it will not appeal the Court of Appeal decision and that it intends to update its policy on grant funding.
Following the Upper Tribunal decision, HMRC had allowed FE institutions to take a more flexible approach in treating public funding as either third-party consideration or outside-of-scope grant funding in Revenue and Customs Brief 8/2021.
However, HMRC has now confirmed that it will update its policy position towards treating such public funding as third-party consideration for exempt supplies of education. Importantly, HMRC states that this policy change will be prospective only and will be implemented through a further Revenue and Customs Brief, which will also provide additional guidance.
Therefore, FE institutions that receive public funding will need to review the VAT treatment of this funding, as more income will become exempt business income at the point HMRC releases its Revenue and Customs Brief.
Impact on the wider charity sectorThe implications of this case are likely to extend beyond the FE sector and are relevant to the wider charity sector where charities receive public funding. Charities in receipt of such funding should reassess the VAT treatment of this income in light of the decision, as reclassification as exempt business income may have significant consequences, including:
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Implications for independent schools and SEN providers
Further consideration should also be given to the potential application of this in the independent school sector. HMRC’s existing guidance for independent schools on bursary funding distinguishes between funding that is assigned to specific pupils and block grant funding, the former it views as being within the scope of VAT. However, the Court of Appeal found that a direct and immediate link could exist regardless of whether funding is allocated to specific pupils. As such, this decision may impact the distinction between third-party consideration for fee payments (subject to VAT from 1 January 2025) and grant funding treated as outside the scope of VAT.
There are potential benefits to providers that are funded by local authorities or others that are in a position to recover VAT on costs. For instance, the special educational needs sector (SEN) may be able to improve VAT recovery as a result of increased taxable supplies being made, where the SEN provider qualifies as a ‘private school’.
Next steps
At this stage, it remains unclear when HMRC’s revised policy will take effect or whether it will be restricted only to the FE sector. It is also unclear if, and how, the policy change will impact FE institutions and other charities that have historically benefited from VAT relief.
Notwithstanding these uncertainties, FE institutions and charities in receipt of public funding should now begin reviewing the VAT treatment of this income, ensuring that appropriate consideration is given to the impact on VAT recovery, VAT registration and reliefs on building projects.
If you would like to discuss how these changes affect your organisation, please get in touch with your usual Crowe contact.
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