HMRC scrutinises VAT grouping structures in the care sector: what do care providers need to know?

HMRC has recently intensified its focus on specific VAT arrangements within the care sector. As detailed in the Revenue and Customs Brief 2, the tax authority has expressed concerns regarding certain VAT grouping structures that may be facilitating VAT recovery in ways that potentially conflict with the intended application of UK VAT legislation. This development represents a significant shift in HMRC's enforcement approach and warrants careful consideration by care providers and their advisors.

In this article we outline the VAT landscape in the care sector, detailing the HMRC's current enforcement activity and its enforcement approach. We also advise next steps for healthcare providers in regards to risk management strategies.

VAT landscape in the care sector

Care services provided by regulated entities, those registered with the Care Quality Commission (CQC) or equivalent regulatory bodies, are typically exempt from VAT. This exemption, while beneficial from a service pricing perspective, creates a substantial commercial challenge as VAT incurred on related costs generally becomes irrecoverable, representing a significant financial burden for care providers operating on already tight margins.

In response to this challenge, the sector has seen the emergence of various group structures specifically designed to optimise VAT recovery positions. These arrangements typically leverage the VAT grouping provisions set out in the Value Added Tax Act 1994.

Structures under HMRC scrutiny

HMRC's current enforcement activity targets a specific structural arrangement that has gained popularity within the sector. The structure under examination typically operates as follows:

1. An unregulated entity (not registered with the CQC) enters into direct contractual relationships with local authorities or NHS bodies for the provision of care services. These supplies are treated as taxable (standard-rated or reduced-rated) for VAT purposes.
2. The actual delivery of care services is subsequently subcontracted to a regulated entity within the same VAT group.
3. This intra-group supply is legally disregarded for VAT purposes pursuant to the VAT grouping rules under section 43 of the Value Added Tax Act 1994.

The effect of this arrangement is that what would ordinarily constitute VAT-exempt supplies, if contracted directly with the regulated provider, are effectively re-characterised as taxable supplies when routed through the unregulated entity. Consequently, the VAT group is able to recover input VAT on associated costs that would otherwise be blocked if the exempt supplier had contracted directly.

HMRC's position and enforcement approach

HMRC has signalled that it views such arrangements as potentially contrary to the intended operation of the VAT grouping rules. While acknowledging that intra-group transactions are disregarded for VAT purposes as a matter of law, HMRC appears to be taking the position that these structures may constitute artificial arrangements designed primarily to secure a tax advantage rather than reflecting genuine commercial and regulatory realities.

The tax authority has confirmed it's actively conducting investigations into such structures and may seek to challenge arrangements it deems abusive or contrived. Care providers operating under such models may therefore face significant risks, including:

• Retrospective VAT assessments
• Penalties and interest
• Denial of historical input VAT recovery

Legal and regulatory considerations

From a legal perspective, these developments raise important questions about the interface between tax law and regulatory requirements in the care sector. While VAT grouping is a legitimate statutory provision, its application must be considered alongside the following key legal principles:

1. Regulatory compliance: the structure must not compromise adherence to CQC and other regulatory requirements governing care provision.
2. Commercial substance: arrangements must reflect genuine commercial substance rather than artificial tax planning.

Risk management strategies

In light of HMRC's enhanced scrutiny, care providers should consider implementing the following risk management strategies:

1. Conduct a comprehensive review of existing group structures, with particular attention to the alignment between contractual arrangements and regulatory status.
2. Document commercial rationale for group structures beyond tax considerations.
3. Consider disclosure under the VAT Disclosure Facility where appropriate.
4. Engage proactively with HMRC where uncertainty exists regarding the robustness of current arrangements.

Next steps

HMRC's increased focus on VAT grouping structures in the care sector signals a potentially significant shift in enforcement policy. Care providers utilising such arrangements should seek specialist legal and tax advice to assess their exposure and consider whether restructuring may be necessary to mitigate risks.

Please contact our specialist tax team and healthcare sector for tailored advice on navigating these complex issues and engaging constructively with HMRC.