In running hospitals, NHS Trusts pay VAT on goods and services but cannot claim any VAT back. This has always been the case and is accounted for in how the Trusts receive their funding.
Then, Trust leaders discovered that under special HMRC Regulations, providers of services outsourced by the NHS can reclaim VAT under circumstances defined in the Contracted Out Services Regulations. Put simply, they can set up wholly owned subsidiary companies (subcos) to register for and reclaim VAT.
Gaming the tax rules
More than a decade ago, several Trusts under financial pressure set out to exploit the above by setting up subcos to deliver a managed service for their premises. In doing so, they transferred cleaners, catering staff, porters, and security staff—often inappropriately termed soft facilities management (soft FM) staff—into the sub-co.
Trusts claimed the sub-co was an ‘independent provider,’ which provided a managed service and could offer benefits such as better staff management and ‘new ways of working’; indeed, it would be free to seek new income from other clients.
This flatly contradicted the simultaneous claim that sub-cos were entirely under the control of the parent Trust and delivered services almost wholly to that Trust and that, therefore, they did not have to undergo formal procurement before awarding a contract (often termed the ‘Tekal exemption,’ now codified in Schedule 2 of the Procurement Act 2023).
Through contrived legal arrangements, the sub-co provided the buildings and facilities from which the trust would provide healthcare services. This met the criteria in the Contracted Out Services Regulations. Because of how the tax regime worked, trusts effectively increased their income by millions per year, and they could also (sometimes) reclaim VAT on capital projects. This was despite the same staff doing the same jobs in the same way with the same managers.
It was obviously tax avoidance, but despite many challenges, questions in the House, and representations from Trade Unions, NHS England refused to intervene. They did, however, issue guidance in 2018 that set out that sub-cos should not be used for tax avoidance!
Under this guidance, a process was set out under which NHS England had to approve the Business Cases of proposals to form subcos. Assurances were also given to the Public Accounts Committee. Trusts were repeatedly told that they should not employ consultants to advise on tax avoidance, yet in every subco proposal, tax advice was taken (often at a large cost) to ensure the subco got the maximum advantage from its tax status.
Because of further claims of abuse that appear to have been substantiated by an internal review by NHS Improvement, NHS England had to amend the Guidance in 2022 and make it even more stringent. This guidance also explicitly made the need to engage widely over proposals, and there was specific guidance on workforce engagement and consultation. This guidance is being ignored.
Trusts also use the flexibility that the subcos had to employ staff on worse terms and conditions to avoid tax avoidance claims and partly to save costs. Business cases prepared to get approval make claims about staff savings and new ways of working, new customers that would buy services from the subco, better recruitment and retention, and much more.
Many Business Cases have come to light, despite Trusts often trying to hide them. They show little care was taken to engage and consult properly, because there would have been challenges. As was found from proper analysis, when these cases did come to light, the claims for other benefits were fanciful at best. Two very public major disputes at Frimley Park and at Bradford led to subco proposals not going ahead because the case put forward was so flawed.
The death of SubCos?
Many thought the age of subcos was over – it was almost impossible for any proposal to stand up to proper scrutiny by NHS England against their guidance. There were requirements for staff engagement at the proposal stage, so all options would have to be explored, and a proper case made. There had to be a “high quality and comprehensive” business case (prepared to the standards required by HM Treasury 5-case model).
Tax avoidance arrangements could not be entered into under any circumstances. If a Trust were to obtain a financial advantage by moderating the tax paid, it would mean that the Exchequer would be worse off, which would conflict with wider duties. Proposals have to set out the commercial strategy for the subco to show how it would bring in additional income from new customers and “income” to the Trust, and financial projections for the subco were required to demonstrate this. There had to be plans to mitigate the risks and clearly explain the capability to deliver on the plans.
The key phrase is that “we expect subsidiaries should largely generate non-VAT savings”. This would obviously include other savings made possible because of the VAT changes as well as the immediate effect – so gains from investment made possible because of less VAT being paid would not count. Cases also had to show that the “savings” could not have been made any other way without a subco.
No business case has ever achieved this high bar: but they have been allowed to progress anyway.
New government backs SubCos
In recent months both the Chief Executive of NHS England and Health and Social Care Secretary Wes Streeting (in a response to a question from the North East at UNISON’s Health Conference in Liverpool) have been openly advocating that all Trusts should set up a subco – to gain the tax advantages.
The only added caveat from NHSE CEO Jim Mackey is that the new subcos would be required to guarantee (if that is possible) to abide by NHS terms and conditions for all staff. This simply replayed the Government’s New Deal arrangements, under which two tier workforces will not be permitted.
New stream of SubCos
The unexpected situation is already being exploited by Trusts moving at pace to set up subcos (Newcastle, Frimley, Dorset and others) without following the guidance and without having to disguise the tax avoidance. This will result, if permitted, in additional funding for the NHS (potentially amounting to hundreds of millions) at the expense of the exchequer generally. This extra resource might be welcome by the NHS, but was not voted for by Parliament.
As is well documented, NHS staff are opposed to all forms of outsourcing, and subcos are outsourcing. A small number of the very early subcos were formed after proper negotiations with staff representatives, as they could see gains for the Trust and believed the assurances given to the small number of staff involved.
However, once the subco formations started to become numerous and were developed without any engagement with staff, failing to abide by the NHS Constitution, it was inevitable that opposition became pervasive. These schemes were allowed despite many major disputes and the obvious tax avoidance. The disputes were even more bitter, and subcos were openly formed to undermine NHS terms and conditions. It is estimated (nothing is published about this) that around 70 subcos currently exist, but in many different shapes and sizes.
Staff have overwhelmingly shown they do not want to be moved out of NHS employment, wherever they have been asked. For those on low pay, employment by the NHS has excellent value, and many Trust managers do not understand this. Attacking the well-established Agenda for Change terms and conditions, which epitomise the partnership working that helped transform the NHS, is wholly wrong. NHS management should not have conspired to undermine hard-won gains.
Many Trusts and some in NHS England have openly threatened that opposition to subcos would just lead to actual outsourcing – which would be even worse for staff.
History has now enabled experience from actual subcos to be examined – although most subcos hide behind alleged commercial confidentiality, making a mockery of the NHS claims to be open and transparent.
Some subcos have done well and in a small number of cases found new clients and rationalised some service delivery. Where all the new clients will come from if every one of 215 set up subcos, and they all try marketing the same services is a mystery.
It is also unclear why service improvement of existing in-house services cannot be achieved through better management, perhaps with some insourced expertise to advise and support change.
Despite the number of subcos formed and the controversy, NHS England has not undertaken any proper independent evaluation although there was some in depth discussion by the then NHS Improvement (now part of NHS England) in 2019 – which appears to confirm suspicions around tax avoidance and which led to the revised guidance. It noted that:
“the category including estates and facilities management, in particular, is becoming increasingly contentious because of the associated changes that these companies bring; often including proposals to move away from AfC pay-scales impacting low paid staff, the dominance of VAT and technical benefits driving the case for change, and the risks associated with transfers of assets into subsidiaries.”
Less formal analysis, for example by campaigners, has shown that most subcos have not achieved the benefits they claimed, although they have got the tax advantages. Some have also gone badly wrong, an experience shared with local government which has also had issues with arm’s length bodies which are also supposed to be under control!
HMRC intervention?
Moving forward, it appears likely that HMRC will have to intervene and enforce its guidance. This could negatively impact existing subcos, who could be asked to repay or justify some tax claimed. A campaign will likely emerge to “ask for our tax back.”
Suppose HMRC weakens its stance and drops its requirements. In that case, it will effectively give tax benefits to all Trusts—so it may as well just give the extra money to all Trusts through some formula rather than the pantomime and overhead costs of setting up and running hundreds of sub-cos (more quangos).
If HMRC (and HM Treasury) cast a Nelson’s eye toward subcos, other solutions are available. It has been regularly argued that getting the tax advantages does not require all the ‘soft FM’ staff to be transferred into the subcos, where their terms and conditions are threatened.
The Contracted Out Services Regulations suggest that the company providing the managed service can subcontract some of the services’ components (in this case, the soft FM staff), which could allow NHS staff to continue to be employed by the NHS in the parent Trust.
Other models may be available. There are also far better ways to improve service delivery, such as working in partnership. Improving service delivery for the benefit of patients should have been the driver for change, not tax dodging.
That this issue has been allowed to fester for more than 10 years by NHS England suggests that it is high time for Ministers to intervene and ban subcos altogether. The NHS should be One Team, employed on one set of Terms and Conditions, and it should definitely not be open to (well founded) accusations of tax avoidance.
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