Court of appeal decision sheds light on VAT treatment of grants

A recent Court of Appeal decision has provided important clarity on how government grants should be treated for VAT purposes – and it may have implications for organisations that receive funding linked to the delivery of services.

In HMRC v Colchester Institute Corporation, the Court of Appeal confirmed that certain government grants received by the education provider were not simply subsidies. Instead, they were payment for a supply of services and therefore constituted consideration for VAT purposes.

What was the issue?

Colchester Institute (the Institute) provided free education and vocational training to eligible students. Although students did not pay fees, the Institute received funding from public bodies. The central question was whether this funding was:

• a general subsidy, sitting outside the scope of VAT, or
• payment made in return for delivering education, meaning it was consideration for a supply of education, a business activity, albeit one that was exempt from VAT.

The Court ultimately agreed with the earlier tribunals that the funding fell into the second category.

Why did the court reach this conclusion?

Rather than focusing on any single factor, the Court of Appeal looked at the overall relationship between the funding bodies, the education provider and the students.

A key starting point was the funding agreements themselves, which required the Institute to deliver specific courses to eligible students. Importantly, the amount of funding received depended on how many students were taught and which courses were actually delivered.

This strongly suggested a two‑way relationship:

• the provider delivered education and training, and
• funding was paid specifically because that education had been provided.

The Court also noted that, although there was no direct contract between the funding bodies and the students, this did not break the link. In practice, legislation and funding rules created a close relationship between all parties involved.

Taken together, these factors pointed to the grants being paid in return for services, rather than as general financial support.

Why does this matter?

This distinction is important because it affects how funding is treated for VAT purposes and can have wider consequences well beyond the grants themselves.

If funding is treated as consideration for a supply, it may:

• increase the level of exempt or taxable income for the organisation;
• affect VAT recovery on costs;
• change the reduced rate VAT treatment of expenses, such as fuel and power;
• impact access to certain VAT reliefs that rely on activities being classed as non‑business. For example, this shift from non-business to exempt business activity has significant implications for VAT relief on buildings and therefore could fail to satisfy the requirement that it be used solely for non‑business purposes. As a result, projects that might previously have qualified for VAT zero‑rating at the construction stage may no longer be eligible for this relief.

For education providers and other publicly funded bodies, this can alter their overall VAT position in ways that may not be immediately obvious.

What happens next?

HMRC has confirmed that it will not pursue any further appeal.

This case highlights that the substance of funding arrangements matters more than labels. Where payments are closely tied to the delivery of specific services, they may be treated as consideration for VAT purposes – even if the end users do not pay directly.

We’re here to help

If you receive grant funding or public sector support and are unsure how it should be treated for VAT purposes, our specialist VAT team can help you review your position and understand the potential implications.