VAT on School Fees! Opportunity in change. (UPDATED)

There has been much debate on Labour's proposal to implement VAT on Independent schools fees. I am not addressing the political argument for state vs independent education. This is a very personal aspect depending on your own beliefs. But I do believe in individuals freedoms to make their own purchase choices free from restrictions.

The announcement on the 29th July at VAT will be introduced from 1st Jan 25 is not an absolute, but a technical note. There is a process to complete before this is implemented & that process is complicated and will likley require regional variation. The 3 page technical note is surprisingly and perhaps deliberately vague.

There is unanswered confusion in this announcement. For example, If a child with special needs goes to a independent school that specialises in this field then UK Gov has said that child will need an EHCP (Education Health Care Plan) and if their local authority can provide this and a parent choses to send to a specialist independent school then VAT will apply. EHCP does not apply in Scotland !

Education is a fundamental right in the UK for every child yet, yet state schools are already stating over capacity. In Edinburgh the majority of state schools advise they are not taking any more applicants. They actually cannot have this position and the local authority must within a reasonable distance from the 'home' find places.

There are two valid and respected sides to this argument and there is an undoubted need to raise tax revenue. Brexit & Covid caused fiscal harm to the UK and this needs to be addressed.

VAT is a mechanism for raising tax revenues on consumption not a tool for passing moral judgement, which is what the rhetoric behind Labours plan feels like. Conversely independent schools on a whole have failed to promoted the benefits and altruistic aspects that they deliver locally to communities and via bursary awards. In the non educational charity world the competition for income capture has forced a better articulation of the good they do and why they deserve your support.

One clear issue is:- Scotland only receives 10% of the VAT it generates from UK exchequer and the Barnet formula is also not linked to tax revenue. Can the UK Gov work outside of the Barnett formula without undermining and fracturing it ?

Also the complexity of VAT means you treat consumption and investment purchases differently so are you consuming an education or investing in one. Is there a legal challenge on VAT law? This is the jaffacake biscuit/cake argument where McVities overturned an HRMC ruling on VAT classification.

I believe there are complexities to over come before this in implemented and likely external legal/VAT challenges which is why VAT on Education was not implemented when it was attempted 30 years ago.

The economic argument is also far from clear. The independent IFS says VAT on School fees would raise £1.6bn but The Adam Smith Institute argue's that depending on migration percentages away from independent to local authority education there it will be much smaller and closer to zero. In a worse case scenario ASI advise it will cost as much as £1.6bn.

They are both right if you only look through each argument with myopic eyes.

The reality will sadly see failure of smaller independent schools who may be most vulnerable. There will be undoubted movement from independent to state the percentage will depend on the price elasticity of parental reaction to how much the fees lift. This places pressure on the independent schools to now act more commercially and to articulate succinctly what they are doing to mitigate this fee rise.

There will be regional winners and regional losers, with Edinburgh looking to be on the losing side such is the weighting % in independent schooling. An argument exists to apply this regionally where there is indeed local authority capacity otherwise the legal right to provide an education for the tax already paid will stress too many local authorities and only lead to legal issues.

One unintended consequence is that independent schooling will be pushed more towards exclusivity as there is a demographic who aren't price sensitive.

But let's assume for the time being this is happening.

With change comes opportunity.

The single most important function of a company is income generation. Ideally multiple income streams.

Independent schools must now look to operate as businesses. This may be cultural shift for some and will require change in the principle founding pillars of others. The smaller Independent schools will be the most exposed (and most likely to fail first) and the argument for paying for early years education (P1-7) across all schools will need to be better articulated.

Strategic certainty will de-risk decision making but only 6% of SME's and corporates have an effective and functioning growth/commercialisation strategy, but those that do, have a significant competitive advantage. I would hazard a guess that across the UK independent school sector less than 6% will have an active functioning strategy to address and capture additional income. This must be a priority for all independent schools and will test boards of governors who have been assembled to guide a charitable operation not a commercial one.

The 20% VAT imposition will not mean a 20% increase in fees as Independent schools will be able to claim the VAT back on allowable expenditure. The real % impact on fees will be somewhere between 8-12%. Before other measures reduce the impact further and this is where it gets interesting.

Let's look at the American education system. This is a commercial success and we can take learning from this.

Commercialising education shouldn't be a 'dirty' term. It also doesn't have to sit only in higher education. There is arguably a global market for educational association or online learning at a distance.

The majority of IVY league and other universities including Harvard, Stamford, Caltech, Berkley etc offer online learning courses for $2-5k for a 6 week course. During spring breaks and summer terms, the classes are full of people taking short term courses, they never close, unlike UK schools & universities.

Harvard University has amassed a fund of $48bn not by accident but by deliberate strategic design. It licenses its brand globally which has become a lifestyle brand similar to NYC, selling products online and in retail stores. It recognises its global brand appeal. How many independent schools can lay claim to having a retail offer ?

Schools such as Fettes, Dollar Academy, ESMS, Heriots, Watson's, Gordonstoun, Glenalmond, Dundee High etc are all globally recognised. Each one has significant value that could be realised from their global reach.

If a company launching to market today wanted to capture the same global awareness (as any of the above schools have) it would require a marketing spend in the high millions.

Yet income generation outside of the principle revenue source (school term fees) is rare to non existent.

My children's former independent school during my son's time didn't look at income generation at all, beyond selling umbrellas in the thrift shop. At one stage they actually rejected an offer by Investec to sponsor their rugby teams such was the total absence of commercial acumen/common sense.

Action.

The threat of VAT should be the catalyst for independent schools to wrestle with the notion that they are an income reliant business first and the provision of in person education is only one income channel. The reality is there at dozens of income channels.

When you consider all independent schools transitioned to online learning during Covid (as failure to not do this would have seen them lose income) yet none (to my knowledge) offer online distance learning as a purchasable product today seems bizarre. There is an untapped global market for UK education at high school level with income to be captured in commercialising this.

Can Independent Schools learn from other economic shocks ?

Can change be a catalyst for opportunity. Yes is the answer as history shows this.

In 2014 the oil price crash forced change across the sector. Prior to the crash the production cost of a barrel of oil was $48 (BOE) with the sale price $100 -$120 (a 160% profit margin). Profits were so abundant that the need for innovation was lost.

This changed overnight when the oil price crashed below $50 and the following year to $27 The industry was in crisis. There was much gnashing of teeth and it highlighted an industry in dire need of change. The major companies were so intrenched in their working methodology that there was no easy identifiable mechanism to reduce production costs, they were stuck extracting at $48 BOE and selling as low as $27.

Along came a small Canadian company (Chrysaor) who purchased ConacoPhillips entire North Sea operation for $2.7bn. Chrysaor had a strategy and implemented it allowing them to extract oil at $26 BOE. They were making profit when all others were haemorrhaging and they changed the sector.

What Now.

There is price elasticity in independent school fees as parents will sacrifice to meet extra costs such is the emotional drivers behind choosing this educational route. Many myself included sacrificed to fund this route. It was my choice and I was happy to make it.

But choice is the key now. Parents have choices beyond sending to sending to state schools. Independent Schools who grasp the commercial 'nettle' and implement other income raising channels will have competitive advantage and raise the emotional appeal over other independent schools who may be slow to act. Schools where their is direct local competition will need to recognise this.

There is an emotional investment and price point for all parents which is no different to any purchase decisions, be that an air fryer, car or house purchase.

The difference between Price Value and Worth will determine the decision to pay a fee increase, send to a state school or switch to another independent school who perhaps demonstrates a stronger commercial acumen &/or better articulation as to why they deserve your business.

There will be consolidation in the independent sector through merger, collapse or slow death through intransigence. This is economic evolution and a 200 year legacy is no barrier to failure when governance fails to implement changes needed to survive. Cut costs, raise additional income or both is the choice.

Those who now act with purpose will capture the opportunity that this has created and will thrive.

Genoa Black has provided advice to the educational sector within the independent and third sector for the last 11 years and we are currently advising a leading UK independent school on their future.

We are always happy to meet to discuss strategy, growth & commercialisation.

It's in the hands of the board of governors now!

Alan K (not independently educated but an advocate of freedom to choose and I chose to send my children down this route)