Revenue and Customs Brief 28/07
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Issued 22 March 2007
VAT treatment of contracted out local authority leisure services
The memorandum of understanding that was jointly agreed by
Customs and Excise and the Chartered Institute of Public Finance and Accountancy
(CIPFA) in 1991 was reviewed in 2006 and this Business Brief contains the
revised version, which supersedes the earlier version (published in Business
Brief 11/99). The revisions have been agreed with CIPFA.
1.1 This memorandum of understanding sets out how VAT is to be applied to the
various supplies that can arise in the provision of local authority leisure
services. The contents have been jointly agreed by HM Revenue & Customs and
CIPFA. The primary purpose is to identify the types of supply that will normally
be encountered and to confirm their correct VAT treatment. It should be noted,
however, that the contents will be subject to review from time to time to
reflect changing commercial practice and any VAT Tribunal or Court decisions in
this area of the tax.
2.1 Local authorities may be involved in the provision of leisure services in
a number of ways:
- by a direct service organisation (DSO) within the local authority’s own
leisure services department;
- through a non-profit distributing organisation (NPDO), eg a charitable
trust or industrial and provident society, in which the authority may have a
degree of representation;
- through a wholly commercial independently owned “for profit” leisure
2.2 In the case of a DSO, all supplies continue to be made by the local
authority and the VAT accounting position is as described at paragraph 5.1
below. However, where the leisure facilities have been developed, owned and
operated by the local authority, and the authority then agrees with an NPDO or
commercial operator that it will take over the operation of the leisure
facilities subject to the authority’s conditions, this process is known as
“contracting out”. The various arrangements that flow from the contracting out
process can give rise to a number of potential supplies for VAT purposes.
3. Who is making the supply of the leisure facilities?
3.1 Deciding who is actually making the supplies to the users of the leisure
facilities is perhaps the single most important aspect to be established, as the
appropriate VAT treatment is dependent on this factor. To answer this question,
all the relevant documentation e.g. the invitation to tender, the final
contract/agreements, back letters and leases or licences and the operational
arrangements that are adopted should be considered, to determine the intentions
of the parties.
3.2 Where operation of the leisure facilities is to be taken over by an NPDO
contractor, it is common practice for the relevant premises to be leased to it
by the local authority in return for the payment of a peppercorn rent.
Thereafter, the NPDO will act as a principal in making supplies to users of the
3.3 An independent contractor will, in most cases, be engaged to run the
leisure facilities as a principal. However, there can be instances where the
contractor will agree to act as an agent of the authority in running certain
facilities. In the past, ambiguous written agreements led to uncertainty over
the status of some independent contractors. In many cases, the agreements failed
to make clear that it was always intended by both parties for the contractor to
act as a principal in making supplies to the general public and other users. To
avoid such problems, current agreements should make clear the status of the
contractor and fully reflect the arrangements under which the parties are to
4. VAT treatment of payments between parties
4.1 Local authorities may make payments to operators of leisure facilities.
However, the nature of these payments can vary and their VAT treatment depends
on the circumstances in which they are paid. In some cases they are simply a
grant and are therefore outside the scope of VAT. In other cases, such amounts
can represent consideration for a supply or third party consideration. Each case
needs to be decided on its own facts.
4.2 Distinguishing between grants and payments can be difficult, especially
when interchangeable terms are used, such as “deficit funding”. Where funding is
freely given, with nothing supplied in return, then the payment is not
consideration for any supply. This is normally the case with grants paid by
public bodies. Conversely, where funding is given in return for specific goods
or services, then that payment is consideration for a supply.
4.3 In recent years it has become increasingly common for grant monies to be
awarded on condition that the recipient enters into a service level agreement
and agrees to meet targets set out in that document. The funding body may even
be entitled to quarterly progress reports. This does not of itself mean that a
supply is being made in return for the funding. These agreements are often drawn
up purely to ensure that the funds are used for the intended purpose, or “good
4.4 To decide whether funding is a grant or consideration for a supply the
following questions must be asked.
- Does the donor receive anything in return for the funding?
- If the donor does not benefit, does a third party benefit instead? And if
so, is there a direct link between the money paid by the funder and the supply
received by the third party?
- Are there any conditions attached to the funding, which go beyond setting
out the terms under which the funds are allocated and the requirement to
account for how the funds are used (commonly referred to as ‘good
In the case of leisure centres, it is important to consider issues such as
the historical provision of the facilities and the relationship between the
parties. The answer to these questions will often indicate the nature of the
4.5 For example, where leisure facilities are developed and owned by an
operator who merely seeks financial support from the local authority for what
has always been the operator’s own facilities, then this support is likely to be
grant funding which is outside the scope of VAT.
4.6 Where, however, leisure facilities have been developed, owned and
operated by the local authority, and the authority then contracts out the
operation of those facilities – imposing conditions upon the contractor - any
payments made by the authority to the contractor are more likely to be
consideration for the contractor’s supply of agreeing to take over the provision
of leisure services under the conditions imposed by the authority.
4.7 Such arrangements, where payments are found to be consideration, can give
rise to various supplies depending upon whether the contractor is acting as an
agent of the local authority or as a principal. Some VAT consequences of these
are described below.
4.7.1 Principal agreements i.e. where the NPDO or independent contractor
supplies the facilities to the user
a) Contractors’ responsibilities
- The payments made by the local authority to the contractor are usually in
the form of an annual management fee and/or a variable “contractor’s deficit”,
normally intended to make good any overall shortfall between the takings and
operating costs. Under the circumstances described in para 4.6 above, this may
represent the consideration for a standard-rated supply by the contractor of
agreeing to operate the leisure facilities subject to the authority’s
- In some circumstances a contractor may be obliged to repay some of the
gross/net profits to the local authority if, for example, they exceed an
agreed level over a period of time (a “contractor’s surplus”). These payments
normally represent a reduction in the management fee payable by the local
authority and VAT credit note procedures will apply.
- Where any monies paid over by the local authority to the contractor are
directly linked to prices charged to users, then such payments may represent
third party consideration for use of the facilities. The contractor is
therefore obliged to account for VAT on the same basis as the normal takings
and this cannot be recovered as input tax by the local authority.
b) Local authorities’ responsibilities
- With the exception of where payments represent third party consideration
as described above, any VAT charged to the local authority by a contractor
acting as principal in respect of the management fee or deficit funding will
be recoverable in full by the authority subject to the normal rules. VAT
charged by the contractor in these circumstances is not attributable to any
lease or licence to occupy granted by the local authority to the contractor.
- There will be a liability on the part of the authority to account for
output tax (subject to an option to tax having been exercised), on any amounts
received in respect of the grant to the contractor of a tenancy or a license
to occupy the leisure facilities. However, where there is no rent or a
peppercorn rent payable by the contractor, the grant of the tenancy or licence
to occupy will normally represent a supply for no consideration.
- Where there is neither monetary payment nor non-monetary consideration
from the contractor to the local authority for a lease or licence to occupy,
this is seen as a non-business transaction for the local authority. Any VAT
which the authority incurs on costs attributable to the premises will be
recoverable under section 33 of the VAT Act 1994 subject to the normal rules.
- Under some arrangements the contractor is obliged, as a condition of
taking over the running of the leisure facilities as a principal, to
periodically pay an agreed fee to the local authority. Provided this is not
rent payable in connection with the granting of a tenancy or licence to occupy
the leisure facilities, it will normally represent consideration for a
standard-rated supply of the granting of the right to operate the facilities
by the local authority to the contractor.
4.7.2 Agency agreements
- The contractor is liable to account for VAT on its supply of agency
services to the local authority. Consideration for this supply will comprise
any amounts paid to the contractor by the local authority and any amounts
retained by the contractor from the takings.
- The VAT charged by the contractor to the local authority will be
attributable to the supplies which the authority makes from that facility. It
must be apportioned between taxable and exempt supplies in accordance with the
authority’s section 33 refund method (i.e. its partial exemption method), and
will be recoverable subject to the authority’s partial exemption position.
- Any amounts paid over by the contractor to the local authority in respect
of the takings collected on behalf of the local authority, will be outside the
scope of VAT so far as the contractor is concerned. The liability to account
for VAT on the takings remains with the local authority (see paragraph 5.1).
- In some cases the contractor may incur operating expenses as agent for the
local authority. Where the supplies are subject to VAT, any entitlement to
input tax deduction rests with the local authority. However, if the contractor
acts in its own name in relation to the expenses there is a requirement under
section 47(2A) VATA 1994 in the case of goods, for the supply to be treated as
being made to and by the agent. Where this applies the contractor may recover
the VAT involved as input tax (subject to the normal rules) and is required to
account for output tax on the onward supply to the authority. Supplies of
services may (if the parties wish) be treated in the same way under section
47(3). There is a requirement to account for the tax on the onward supply in
the same tax period as it was recovered.
5. Liability of supplies to users of the leisure facilities
Where supplies are made by a local authority
5.1 The supply of leisure activities will continue to be made by the local
authority in circumstances where a DSO is set up or where a contractor is
brought in to run the facilities as an agent of the authority. In these
circumstances the local authority is liable to account for VAT on the takings at
the standard rate for all supplies other than those that may be exempt under the
VAT Act 1994, schedule 9, group 1(m) (note 16) (Single lets for over 24 hours
and a series of single lets to the same person) – see Notice 742 Land &
Property– and group 6 (education) – see Notice 701/30 Education & Vocational
Where supplies are made by a NPDO contractor
5.2 The liability to account for VAT on the takings rests with the NPDO. Some
supplies may be taxable and others eligible for exemption under the VAT Act
1994, schedule 9, group 1(m) (note 16) and group 6 (see paragraph 5.1 above), or
group 10 (sporting services supplied by non-profit making organisations and
competition entry fees - see Notice 701/45 Sport).
Where supplies are made by an independent contractor
5.3 Where the contractor acts as a principal any supplies made to the users
of the leisure facilities will be liable to VAT at the standard rate unless
exempt under the VAT Act 1994, schedule 9, group 1(m) (note 16) (see paragraph
5.1 above) and group 10 (Item 1) (competition entry fees - see para 5.2 above).
Further supplies made by either contractor to users
5.4 There may be further supplies made in the course of operating leisure
facilities such as room hire, crèche facilities and catering franchises. The
liability of these will vary and may include additional exempt supplies.
6. Further advice
6.1 This memorandum covers only the basic arrangements that can apply to the
operation of contracted-out local authority leisure services. Those involved
should consult the HMRC National Advice Service on 0845 010 9000 if they require
further guidance on any of these aspects, or if there is anything not covered
About the Author
© Crown Copyright 2007.
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Article Published/Sorted/Amended on Scopulus 2007-03-22 23:11:52 in Tax Articles