Although the decision concerned a further education college, the principles are of general application to any organisation in receipt of Government or public-sector funding. The implications are particularly significant in the public, housing, and development sectors, including in relation to affordable housing grants, commissioning payments, and section 106 contributions, but extend to any entity whose funding arrangements exhibit the hallmarks identified by the Court.
The key VAT risk for bodies (both public and private) receiving grant funding is that such grant funding may not be "outside the scop" of VAT but may instead be consideration for a VATable (or VAT exempt) supply. This could require VAT to be accounted for in respect of such grant funding and could also affect VAT recovery and available reliefs.
The Court of Appeal's decision makes it necessary to properly consider each grant funding agreement or arrangement for VAT (and potentially other tax) purposes.
HMRC has recently confirmed in Revenue and Customs Brief 3 (2026), that it will not be appealing this decision, and that further guidance is awaited.
What did the Court decide?
On 27 March 2026, the Court of Appeal unanimously dismissed HMRC's appeal in HMRC v Colchester Institute Corporation [2026] EWCA Civ 363, confirming that Government funding received from two Government agencies by a further education college constituted "consideration" for VAT purposes.
The agencies in question, the Education Funding Agency and the Skills Funding Agency, had paid Colchester Institute Corporation approximately £18.5 million and £4.2 million per annum respectively to fund education and vocational training for eligible students.
The central question was whether this funding was a general grant conditional on Colchester Institute Corporation providing courses or whether it was payment for the provision of education to identifiable students. The Court held it was the latter, applying a multi-factorial analysis focused on the terms of the funding agreements, which contained express reciprocal language, per-student reporting obligations and clawback provisions tied to delivery of the education or training.
The Court's decision follows several years of litigation with the Colchester Institute Corporation having already been successful twice on essentially the same issue before the Upper Tribunal. First in 2020, and then in 2024.
When Does Funding Become Consideration?
The critical distinction is between a payment to fund an organisation's general activities (a true grant, outside the scope of VAT) and a payment made in return for the provision of services to identifiable recipients (consideration for a supply).
The Court identified four hallmarks in these circumstances that pointed toward consideration:
- reciprocal language - contractual wording recording that funding is paid in return for the performance of specified services;
- per-beneficiary reporting - obligations to report data on each individual learner, resident, or service user;
- clawback provisions - requirements to repay funding not applied to delivering the specified services; and
- commercial logic - where the same services are also provided to self-funding recipients, it is incongruous to treat the publicly-funded provision as anything other than a paid-for service.
The Court also made clear that a payment does not cease to be consideration merely because it takes the form of a flat rate or annual fee rather than a per-transaction charge, nor because it is made by a third party (such as a Government funder) rather than by the recipient of the services.
Historically, bodies receiving grant funding have tended to place significant reliance on HMRC's guidance. This guidance only provides an outline of the factors that HMRC will consider when deciding whether a particular grant is outside the scope of VAT. While the Court did not comment specifically on this guidance, the Court's failure to side with HMRC indicates that the guidance should be treated with some caution.
It is interesting to note that HMRC's guidance (which has not been updated since the Court of Appeal's decision) is contrary to the position adopted by HMRC in arguing its case before the Court. The guidance provides that the following is evidence that a grant payment is for a supply:
"the payments made by the funder to the supplier are made specifically for the supplier to provide particular services to its clients. The fact that the funder does not know at the time the service is provided the identity of the client or the even the specific service which is being provided is not relevant"
Although HMRC's guidance also notes that certain grant funding between different bodies in central Government should always be treated as outside the scope of VAT, this is not the case for bodies like local authorities and charities (including, evidently, further education institutions), as well as businesses. Therefore, the Court of Appeal's analysis will be relevant to many different bodies including (and most directly) bodies receiving education-related funding.
What Issues Could Arise from the Incorrect VAT Treatment of Grant Funding?
If a body receives grant funding that it treats as outside the scope of VAT, but which is actually consideration for a supply for VAT purposes, this could result in one or more of the following issues:
- output VAT could be chargeable on the grant funding; as most grants are "inclusive of VAT" this means that the grant funding received could be reduced, in practice, by up to 17.67%;
- input VAT recovery could be increased or reduced depending on whether the supply is VATable or VAT exempt;
- partial exemption and business/non-business apportionment could be incorrect (this is of particular concern to local authorities given the "cliff edge" nature of their VAT partial exemption disregard);
- VAT zero rating could fail to apply to certain development projects where it had been expected; in particular grant funding provided to charities claiming VAT zero rating on development for a "relevant charitable purpose".
As well as prospective issues, these issues could apply to historic transactions.
The effect of the Court of Appeal's decision on further education bodies is clear. However the Court of Appeal's decision could be very relevant to two other types of body: housing associations and local authorities.
How Might the Court's Decision Affect Housing Associations and Registered Providers?
Housing associations frequently receive grant funding from Homes England, the Greater London Authority, local authorities and other public bodies for the development and delivery of affordable housing and associated services. The principles in this decision apply directly to those arrangements.
Where a funding agreement requires a housing association to deliver affordable homes or support services to identifiable households, contains per-unit or per-household reporting obligations, and includes clawback provisions tied to delivery targets, the Court of Appeal's decision strongly supports the characterisation of that funding as consideration for a supply rather than as a general grant.
How Might the Court's Decision Affect Local Authorities?
Local authorities act both as recipients and providers of grant funding. Local authorities should consider the Court of Appeal's reasoning in both capacities.
Local authorities may be involved in both, or either of, the provision of education and social housing. In these cases the Court of Appeal's decision may be relevant.
The Court of Appeal's decision is also of particular interest to local authorities given the importance of grant funding to their activities and the already existing VAT difficulties that this poses.
For example, we have seen infrastructure and development projects where the grant funding provided to local authorities risked being consideration for a VATable activity. These types of arrangements will need to be considered in light of the Court of Appeal's reasoning. This obviously creates risk for local authorities for the reasons set out above.
We have also seen issues arise where a local authority provides grant funding to another entity for an activity that is later determined to constitute a VATable business activity of that entity. Where a local authority has made that grant funding "inclusive of VAT" to protect its position, this will cause an issue for the recipient of the grant. The grant funding available to the recipient of the grant will be reduced as it will have to account for VAT to HMRC and so the recipient may struggle to achieve what the grant funding was intended for.
HMRC's Response: Revenue and Customs Brief 3 (2026)
HMRC has recently published . In the Brief, HMRC confirmed that it will not appeal the Court of Appeal's ruling and stated that it will consider the terms of the judgment in consultation with relevant stakeholders, with any policy change to be announced by way of a further Revenue and Customs Brief accompanied by updated guidance. Although the Brief is addressed specifically to further education institutions, the principles underlying the Court of Appeal's decision are of direct relevance to the real estate, housing, and development sectors, and the approach HMRC adopts in response may signal how it will treat analogous funding arrangements in those sectors.
It is important to note, however, that (with very limited exception) HMRC guidance (including Revenue and Customs Briefs) does not have the force of law. The Brief represents HMRC's interpretation of the law, but it does not bind taxpayers or the Courts. As a matter of course, taxpayers should exercise caution before placing undue reliance on HMRC’s published position, but especially where, as here, HMRC has committed to undertake a policy review and update its published guidance. This uncertainty makes taking appropriate tax advice all the more critical.
Is VAT the End of the Matter?
VAT is not the only tax issue that can arise with grant funding. For example, in the case of grant funding for real estate development, the construction industry scheme (and its exemptions) may be relevant. Equally, the receipt of grant funding by businesses can reduce capital allowances that may be claimed, or be treated as a revenue receipt for corporation tax or income tax purposes.
