Colchester Institute VAT case and what charities need to know

A recent Court of Appeal decision in Colchester Institute has clarified how certain government funding should be treated for VAT purposes, with implications that may reach well beyond the education sector. While the case focused on funding received by a further education college, the judgment could affect any charity or not-for-profit receiving public funding linked to the delivery of specific services, particularly where VAT recovery and partial exemption are concerned.

Background

Colchester Institute Corporation (Colchester Institute) is a further education college providing education and vocational training, including courses delivered free to eligible students. Colchester Institute received funding from government agencies, including the Education and Skills Funding Agency, to support the delivery of the courses. Historically, HMRC treated such funding as non‑business grant income, and accordingly outside the scope of VAT. Colchester Institute challenged this position, arguing that the funding constituted consideration paid by a third party for the supply of education services.

On 27 March 2026, the Court of Appeal (CoA) dismissed HMRC’s appeal and upheld earlier tribunal decisions in favour of Colchester Institute. The CoA concluded that the funding was paid in return for Colchester Institute delivering approved education courses to eligible students and was not general financial support. Applying an analysis based on several facts, the CoA found a direct link between the funding and the education provided. As a result, the funding was treated as third‑party consideration for a supply of education, rather than as non‑business income.

However, although the CoA found that the funding constituted consideration for a supply, the supply of education itself remains VAT‑exempt under the education exemption.

Implications

The key change is therefore not that VAT becomes chargeable on the income, but that the activity is classified as an exempt business activity, rather than a non‑business activity the latter that would have been treated as outside the scope of UK VAT. This may result in more exempt income being received by certain education instutitions, potentially with less VAT recovery, in accordance with the partial exemption method in place.

HMRC has confirmed, within its recently published Revenue and Customs Brief 3 (2026), that it will not appeal the CoA decision. However, HMRC has indicated that it will update its policy to reflect the judgment. More importantly, HMRC has stated that any change in policy will apply prospectively only and from a future date to be announced. Education institutions which have not previously adopted the third‑party consideration approach, will not be required to revisit historic periods.

How Gravita can help

The reclassification of public funding so that it falls to be treated as exempt business income, may therefore have significant practical consequences. These include changes to partial exemption calculations and potential restrictions on the recovery of input VAT, as mentioned above. Educational institutions may also need to reconsider their entitlement to certain VAT reliefs that depend on activities being treated as non‑business, such as zero‑rating for the construction of new charitable buildings and reduced rates for fuel and power.

While the case concerned a further education college, the reasoning may be relevant to other organisations, including charities and education providers, that receive public funding tied to the delivery of specific services. We would recommend that organisations that may be impacted by the above decision, should review its funding arrangements to assess whether similar VAT issues could arise.

We will continue to monitor further guidance from HMRC and provide an update for to assist those organisations in considering a review of their VAT positions, particularly in relation to partial exemption methods and capital projects, as an early assessment will help ensure that systems and VAT recovery methodologies remain compliant once HMRC’s updated policy is implemented.

Next steps

If you’d like to understand what the Colchester Institute ruling could mean for your organisation, get in touch with VAT Partner, Sandy Cochrane for practical advice on reviewing your VAT position, funding arrangements and recovery approach. You can also read the latest edition of the quarterly Gravita charity bulletin and sign up for future updates.