Upcoming Challenges for The Independent School Sector

There has been a plethora of media coverage surrounding the flagship policy, ending the VAT exemption for independent schools and their current charitable status is nuanced. It is unclear whether a legislative change will need to be made to distinguish between independent schools, universities and academies, leaving governors, headteachers and parents nervously awaiting clarification as to what and when any policy change could be introduced.

The Institute of Fiscal Studies suggests that ending the VAT exemption for private schools will raise £1.6 billion, enough to fund an additional 6,500 teachers in the public school system. When delving into the detail, the headline figure assumes a 3%-7% reduction in private school attendance, which may be acutely underestimated and does not account for the cost of educating such students within the state system, at an estimated cost of up to £0.3 billion.¹

The assumed reduction in school pupils is at odds with independent research that indicates that the effect of a change in policy would range from ‘tough’ to ‘catastrophic’ for independent schools as parents struggle to afford private education, resulting in a large number of pupils being required to be educated by the state.²

The Labour party is relying upon falling birth rates since 2013 to mitigate the increase in demand within the state school sector, with capacity assumed to be available to absorb displaced students.

Contrary to such views, a survey by the National Governors Association cites that 58% of schools do not have falling numbers of pupils and 35% of schools do not envision this to become a problem³, with governors reporting that students from independent schools are turned away and are spending extended periods of time out of the education system.

Overall, the policy could displace 75,000 students by September 2025³, with 35% of which is expected to be as a result of the forced closure of independent schools that are no longer deemed to be viable⁴. Over the course of secondary education, this is expected to contribute to a significant reduction in VAT earned on fees of £0.5 billion, further eroding the headline benefit of £1.6 billion⁴. This does not include the impact of potential unemployment costs to the taxpayer or insolvencies of operators within the education supply chain.

The media portrayal of super wealthy parents opting to educate their children privately is a far cry from reality. The circumstances of parents are more varied than what media reports and parents are often making considerable sacrifices. While parents of pupils at the most exclusive schools may be resilient to price increases, it is likely that this level of increase would deter some parents from choosing the private sector for their children.

The potential introduction of VAT compounds the challenges faced by parents against the current backdrop of rising inflation and the cost-of-living crisis, with fees increasing by an average of 8% last year in line with inflation, as necessary for schools to simply stand still. Based upon average annual day fees of £18K, as reported by the Independent Schools’ Council, the combination of VAT and similar inflationary pressures would result in a further potential increase in fees of £5K per pupil, which may be a step too far for many parents⁵.

Given the 5 to 7-year operating cycle of a school, a poor intake can result in lower revenue over a full cycle, as few students move from state schools after the initial intake. With half of all private schools having fewer than 285 pupils and one quarter having fewer than 153 pupils, every student matters.

With the current uncertainty, it is vital that scenario planning starts now to allow stakeholders to effectively manage the potential loss of students and to take appropriate mitigating actions. For schools facing cashflow issues, a reliance on fundraising from alumni is one possible solution, especially as donations are not taxed, albeit this may only be an effective solution for the more prestigious independent schools. Early engagement with networks is important to deliver an effective solution as many strategies will take time to implement.

Good systems and processes for chasing late payers will become more critical than ever. Schools should look to invoice in advance where possible and engage in regular communication with parents who have struggled to make payments previously, with payment plans formalized, when required.

In extreme cases, governors may consider changing the operating model of their schools. There are more schools merging or forming groups than ever before as the sector becomes consolidated. The 256 single-sex schools may consider becoming co-ed schools, whilst those attached to loss making nurseries or sixth forms may choose to streamline their operations. It should be noted that it is unclear if these changes will affect special educational needs and disabilities schools (“SEND”).

There will be a lot of uncertainty if the VAT rules change for private schools, however, proactive and robust financial modelling can identify potential future shortfalls and stress points. Finance teams should ensure that they understand VAT reclaim rules and that debtors are up to date, with a policy in place for those in arrears.

After delving into the details, the headline grabbing £1.6 billion of VAT generated under the policy change may be reduced by up to 50% and therefore may not be as lucrative as it first appears. Not only does the change create significant turmoil and upheaval for parents and students alike, against the backdrop of a challenging wider macro-economic environment, the policy change poses significant stresses on independent schools. In the worst case, this may result in a wave of school closures and at best, trigger schools to make drastic changes in their operating environment necessary to remain viable.

Kroll has strong connections with the Department of Education and is well-placed to advise and provide workable solutions to institutions. Please contact us if you require support.

Sources:
¹IFS - https://ifs.org.uk/publications/tax-private-school-fees-and-state-school-spending
²Baines Cutler - https://www.bainescutler.com/media/2umbzz1c/isc-vat-full-report-1018-for-circulation.pdf
³The Times - https://www.thetimes.com/uk/politics/article/priced-out-of-private-education-and-turned-away-by-the-local-school-bzfrctr33#:~:text=Priced%20out%20of%20private%20education%20%E2%80%94%20and%20turned%20away%20by%20the%20local%20school,-Governors%20are%20spending&text=State%20school%20governors%20have%20reported,no%20longer%20afford%20the%20fees.
⁴Baines Cutler - https://www.bainescutler.com/media/zjyd2znt/vat-in-10-tweets-baines-cutler.pdf
⁵Independent School Census 2024 - isc_census_2024_15may24.pdf