Contact: Jon Pittam, ext 7400

1. Summary

1.1 This report sets out a number of issues that will have a direct effect on the County Council's ability to continue to recover all the VAT it incurs. This issue is particularly critical for schools and Recreation and Heritage services. The following decisions are sought:

1 That in the absence of any changes to the definition of exempt income or to the 5% partial exemption limit, the County Council adopts policies where legally feasible which are designed to prevent exempt income being generated from the adoption of new initiatives which result in the 5% limit being breached:

· that all nurseries under the neighbourhood nursery initiative be run by third party organisations

· that nursing home places provided by the County Council be confined to Hampshire residents

· that the scope for phasing the impact of capital costs by adjusting the programming of capital projects for sports and community facilities which generate exempt income be reviewed.

2 That representations be made to Government, both direclty and through the Hampshire MP's, seeking to widen the definition of non business local authority activity or to obtain a temporary relaxation of the 5% limit.

2. Reason

2.1 The Cabinet need to be made aware and kept abreast of developments that could potentially impact on the County Council's budget.

3. Other options considered and rejected

3.1 Not applicable.

4. Conflicts of interest declared by the decision maker or a member or officer consulted

4.1 Not applicable.

5. Dispensation granted by the Standards Committee

5.1 Not applicable.

6. Reasons for the matter being dealt with if urgent

6.1 Not applicable.

Approved by: Date:

Councillor T K Thornber

Contact: Jon Pittam, ext 7400

1. Introduction

1.1 Hampshire County Council operates, like all local authorities, under a special regime for value added tax (VAT) known as section 33. Under section 33 the County Council is allowed to recover all the VAT it incurs.

1.2 There are a variety of VAT treatments that the County Council is subject to:

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1.3 The general rule is that any VAT incurred in the provision of exempt supplies is not recoverable, but there is a de minimis level of 5% for local authorities. Each year all local authorities must undertake a section 33 or partial exemption calculation. If more than 5% of the tax that the County Council pays on goods and services is attributable to exempt activities, then its ability to reclaim the tax on all the expenditure incurred from exempt activities is lost. At a very rough estimate this could be as much as £2m-£3m for each year the threshold is breached. In addition it would require a considerable amount of work to identify the VAT in question. The majority of the exempt income generated relates to schools and recreation and heritage services, so that the main impact of breaching the 5% limit would fall upon those services and upon the funding of capital projects.

1.4 In the past the County Council has been stable at around the 4% mark. New initiatives did not generate much additional exempt income so breaching the threshold was not an issue. However, central government schemes and initiatives have the potential to increase significantly the amount of exempt activities the County Council generates. Central government departments are not particularly aware of VAT issues and introduce initiatives without in many cases consulting with Customs and Excise and with little appreciation of how they could affect local authorities' VAT position.

1.5 The last calculation that has been completed was for 2001/02 at which point the County Council stood at 3.92%. This was based on all expenditure that would generate exempt income whether capital or revenue and included monies from such sources as the lottery and other government funding for sports and community projects.

1.6 Some £3m of additional expenditure, either capital or revenue, that generates exempt income would push this beyond the 5% threshold. There are a number of new initiatives under consideration which could push the County Council above this threshold, which are summarised below.

2. Neighbourhood Nursery Initiative

2.1 Government funding has been received with the intention of setting up nursery places at several sites. The provision of nursery education is an exempt supply generating exempt income for the County Council. It has been possible to create a model whereby the County Council will not generate exempt income, by letting the building to a third party to run it and opting to tax the rental. However, it may not be possible to implement this option if the third party obtains charitable status, which is the current plan. This matter is being considered by counsel. However, two of the proposed sites do not currently have a third party to run them.

2.2 Some £2m of capital works will fall into the County Council's calculation if the County Council run these two sites. The only other way to avoid this is if the nursery service is provided free of charge.

3. Nursing Homes

3.1 Funding provided under a transfer of power from the National Health Service (NHS) via Primary Care Trusts will allow the County Council to construct and run nursing homes to alleviate the problems of bed blocking. The transfer of power will enable the County Council to provide the service to Hampshire residents as if it was part of its statutory function.

3.2 However, if places are offered to clients outside the County Council (for example from other local authorities, including Portsmouth City Council and Southampton City Council) the provision becomes an exempt welfare service generating exempt income. Given that the capital works involved could be around £60m the relevant proportion of external beds would then need to be included in the County Council's partial exemption calculation, sending it over the threshold.

3.3 To avoid this situation arising it is important that only Hampshire County Council residents are allowed to use these facilities.

4. Community Facilities Power

4.1 Under this power community schools are encouraged to increase the community facilities available to the public and promote their use. Much of this income will be from lettings which will in the main be exempt income.

4.2 Schools can submit bids for funding direct from central government and the County Council can only advise them on their business plan, it does not have the power to intervene.

4.3 This is a potential problem as the generation of exempt income here has been taken out of the County Council's control.

4.4 The options for reducing the amount of exempt income generated are limited. Sports lettings are standard rated unless booked as a series of lets of ten or more in which case they become exempt. This is normal practice. An option available is to restrict to nine lets making them all standard rated, but this could make the facilities less competitive and reduce income, and the County Council has no powers to enforce such a policy.

5. Lottery Funding

5.1 Hampshire schools can already submit bids for lottery funding to construct sports facilities and these already have a significant impact on the level of exempt income that is generated.

6. Conclusion

6.1 It is unfortunate that the 5% de minimis limit on exempt supplies has become a consideration in determining how various initiatives involving exempt supplies are implemented. This is particularly the case where the avoidance of VAT exempt income may lead to poorer value for money for the public sector as a whole. In many cases the provision of grant and other financial support from national bodies is conditional upon community access. However in view of the number of such initiatives and the scale of the capital works involved, it is unlikely that the County Council can continue to remain within the 5% limit without adopting policies where feasible designed to limit the generation of exempt income. The County Council only needs to exceed marginally the 5% limit to lose the ability to reclaim any VAT on exempt income and increase the County Council's annual spend by up to £3m.

6.2 However as the major issue is the concentration of capital schemes generating exempt income, the main problem may be in avoiding temporarily breaking the 5% limit while higher levels of capital expenditure are being incurred. The options to tax for sports and other lettings would involve a loss of income for a 20 year period and would be very difficult if not impossible to implement and thus this is probably not a realistic or proportionate policy to adopt. Policies designed to avoid exempt income being generated by the County Council from nursery facilities and from nursing care homes seem more likely to be achievable and effective, but are still subject to further clarification of the legal issues.

6.3 The other option for seeking to reduce the likelihood of breaching the 5% limit is to review the phasing of capital projects relating to facilities generating exempt income, where none of the other policy options to avoid exempt income is feasible. This is a particular issue in 2003/04 because of the build up of sports hall projects generating funding from the new opportunities fund of the national lottery. If the 5% limit is exceeded the capital cost of all the projects will increase as VAT will no longer be fully recoverable on the construction costs. However as most Government and Lottery grants include conditions requiring expenditure to be incurred or committed by a specified date, the scope to influence the phasing of capital expenditure will be limited. More work also needs to be done to establish what proportion of the capital costs of particular projects is likely to be included in the partial exemption calculation.

6.4 A further option is to seek to persuade the Government to widen the scope of non-business activity to include services which are not currently treated as statutory services , but where it is clearly the Government's intention that local authorities should engage in the provision of such services in a way which generates exempt income. These issues are being taken up with Government via the Local Government Association, County Council's Network and the Society of County Treasurers. Alternatively if the partial exemption limit is only likely to be breached on a temporary basis it may be possible to negotiate a temporary dispensation with Customs and Excise.

Recommendation

1 That in the absence of any changes to the definition of exempt income or to the 5% partial exemption limit, the County Council adopts policies where legally feasible which are designed to prevent exempt income being generated from the adoption of new initiatives which result in the 5% limit being breached:

· that all nurseries under the neighbourhood nursery initiative be run by third party organisations

· that nursing home places provided by the County Council be confined to Hampshire residents

· that the scope for phasing the impact of capital costs by adjusting the programming of capital projects for sports and community facilities which generate exempt income be reviewed.

2 That representations be made to Government, both directly and through the Hampshire MP's, seeking to widen the definition of non business local authority activity or to obtain a temporary relaxation of the 5% limit.

Section 100 D - Local Government Act 1972 - background papers

The following documents disclose facts or matters on which this report, or an important part of it, is based and has been relied upon to a material extent in the preparation of this report.

NB the list excludes:

Published works.

Documents which disclose exempt or confidential information as defined in the Act.

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