In this time of financial challenge for the delivery of public services, it is crucial for local authorities to be mindful of the potential tax costs, as well as cash saving opportunities, that arise from the complexities of local government service delivery and structures.

In our latest Time to Talk, we invited experts on tax and pensions from across KPMG to focus on common tax pitfalls, as well as maximising the potential to gain much-needed revenue or tax relief from using the most appropriate commercial arrangements.

The biggest take-away for councils is that it is important to seek tax advice as early as possible in a transaction or commercial structure in order that opportunities can be taken and commercial arrangements do not give rise to unexpected liabilities.

Complex rules governing VAT present great opportunities, but also risks

VAT compliance

Due to increased numbers in HMRC’s public bodies team, we are seeing increased inspection activity (both remote and in person) across the public sector, including in local authorities.  An area where errors typically arise in local authorities is on the VAT treatment of income, as there can be complexities that mean that treatment relating to similar looking activities can differ.  Ensuring that there are suitable processes and controls in place around income is key to minimise the risk of errors arising and potential penalties being incurred.  Having these in place before a HMRC visit can also help to demonstrate ‘reasonable care’, which further minimises risks around penalties.

On the expenditure side, local authorities benefit from very generous partial exemption rules, which typically allow all VAT properly incurred to be recovered in full.  However, it is important that the annual partial exemption calculation is carried out to confirm that the 5% de-minimis limits has not been breached, otherwise a repayment may be due to HMRC.  As important is ensuring that the annual calculation is carried out correctly, so that the result is not distorted by errors.  Completing the calculations in a timely manner is also important as this would regularly be reviewed as part of any HMRC inspection.

Delivery of leisure services

In early 2023, HMRC accepted that sporting services provided by a local authority is a non-business activity, and therefore outside the scope of VAT.  This led to significant VAT refunds being obtained by many local authorities.  More recently, we are aware that there are some local authorities and their leisure trust partners exploring ways in which the change in VAT rules for local authorities could open up opportunities to provide access to sporting facilities at a reduced overall cost for both parties.

Increased focus on employment taxes issues by HMRC

In December 2022, HMRC issued letters on off-payroll working to all local authorities outlining the issues and demonstrating an increased interest in ensuring compliance. Following on from this, we  are now seeing HMRC opening reviews, asking local authorities to complete detailed questions and provide information to enable them to undertake compliance checks.

In our experience, the information requested can often be difficult for local authorities to provide, for example confirming how many employment status assessments have been undertaken and of those, how many resulted in an inside IR35 assessment.  In most cases this is due to the fact the process is not centralised resulting in the information, if available, being spread across the authority and very difficult to collate. HMRC have provided guidance outlining the processes and controls they expect all organisations to have in relation to employment status and local authorities should be considering if their current processes are both fit for purposes and would enable them to respond to HMRC in both a comprehensive and timely manner.

Another area of focus from HMRC during their reviews is the Construction Industry Scheme. Whilst most local authorities operate the scheme, the ongoing compliance can often be overlooked or become formulaic. For example, suppliers are often only assessed for CIS by the local authority on their first contract to determine if the scheme is applicable. As the application of the scheme is dependent upon the services contracted for, not the supplier, where a supplier can provide a range of services it could be that the second or third engagement falls within the scheme and therefore these later contracts are incorrectly ignored for CIS purposes. This can then lead to significant liabilities as construction contracts can be of high value.

For anyone involved in CIS, HMRC guidance can be a very useful starting point for understanding the rules however it is important that this process is reviewed to ensure the correct reporting is being undertaken.

Spring Budget 2024

Arguably, the biggest winner of the Spring Budget were the creative industries, with many enhanced tax reliefs introduced during COVID now made permanent. The creative industries tax relief generally of most interest to local authorities is Museums and Galleries Exhibition Tax Relief, which can be claimed if an exhibition is run by a narrowly defined group of bodies including local authority subsidiaries.

For councils that spend material amounts on museum and gallery exhibitions, it could be worth examining the structure of managing those exhibitions and claiming the tax relief – for every £100 of qualifying expenditure, the local authority subsidiary can claim back up to £36 in cash.

Consider tax advice early to ensure the commercial arrangement is right for the type of activity you wish to pursue

It is important councils keep in mind that while they themselves are not subject to corporation tax, the starting point is that their subsidiaries are. The legal and operational structures of those subsidiaries can have a significant impact on the amount of tax payable and can lead to liabilities which render some projects unviable. It is important to understand the impact of the proposed structures as early as possible so that no time or money is wasted setting up subsidiary structures which are not efficient from a tax perspective.

For example, subsidiary companies buying land from the local authority to develop may end up with a significant tax liability on the difference between the original cost of that land to the council (which in many cases is very low) and the market value at the date of sale to the subsidiary; this may be a significant amount and make the entire development project untenable.

Local government pension schemes are in an enviable position, presenting savings opportunities for councils

One year away from the next Local Government Pension Scheme’s valuation, due as at 31 March 2025, the funds are in a better-than-expected position. Yields of UK bonds have seen a high of 5% at the time of Liz Truss’ budget and have since stabilised between 4-5%. This is important for local government pension schemes because the value of liabilities in pension funds is low  when yields on UK bonds are  are high, and vice versa. Should market conditions we would expect LGPS funds to be well funded and in a surplus position at the next valuation.

Now is a good time for councils to engage with their LGPS fund, as the positive outlook means councils have no deficit to recover, (meaning no payment of secondary contributions) and  may expect to pay a reduced primary rate if they are able to realise a credit where there is a surplus. However, some LGPS funds have started re-evaluating their funding methodology with a view to increasing the level of prudence, which would impact the position and prevent the good news being passed on to employers. Councils should engage with any consultation on changes to funding methodology to ensure their views are heard, particularly in light of budget constraints and a focus on costs.

In addition, many LGPS funds are revising the terms applied when an employer exits the fund. This should matter to councils, who   often act as the guarantor of outsourced contractors. Local authorities can, in some cases, make the argument that upon an exit of a provider from the LGPS fund or at the end of the contracted services, any surplus (exit credit) should revert to them, having acted as guarantor, rather than the provider. As a matter of good governance councils should undertake a review of contracts where they act as guarantor to ascertain the position on termination.

To discuss your circumstances or any of the above in more detail, please contact any of our speakers at this event:

Peter Chapman – Director, UK Head of IGH Tax, KPMG

Urrffa Rafiq – Director, Pensions, KPMG

Paul Moreels – Director, KPMG