Karin Smyth – 2020 Speech on VAT Rules and Hospital Improvement

Below is the text of the speech made by Karin Smyth, the Labour MP for Bristol South, in the House of Commons on 9 January 2020.

It is a pleasure to see you in the Chair for this debate, Madam Deputy Speaker.

I am pleased to have been granted this debate at a significant time in Parliament, following this evening’s votes. I hope to shed some light on how complicated VAT rules, which have evolved over time in the NHS, are now creating incentives for trusts to behave contrary to the Government’s objectives, in particular those relating to capital investment and the implementation of the long-term plan.

I am pleased to see the Minister for Health here to answer the debate. My expertise in the finer aspects of taxation policy and its operation is fairly limited, and I do not believe that he is a tax expert either, but before I came to this place I spent most of my professional life as an NHS manager so I know a lot about planning and delivering health services, including new hospitals. The Minister has clear policy objectives as the Government work to implement the NHS plan, which is predicated on place-based commissioning and improved capital infrastructure. I believe that, as the Minister for Health, he has an obligation to support NHS leaders by providing greater clarity on how the rules operate. Indeed, the Office of Tax Simplification agrees with me that this is a problem, with its 2017 report recording frustration

“about a number of cases where the VAT position was unclear…with HMRC and government tendering departments having differing interpretations.”

It noted that

“VAT liabilities should be clearly outlined during the tendering process for public services and contracts.”

The Government also appear to agree, and the spring statement announced a policy paper, although it was vague on details. The announcement was for:

“A policy paper exploring a potential reform to VAT refund rules for central government, with the aim of reducing administrative burdens and improving public sector productivity.”

The 2019 OTS update noted that that spring statement had involved a commitment to

“a policy paper on VAT Simplification and the public sector”.

It is essential to raise this issue now, because as we move towards implementing the NHS Plan we all need to understand exactly how the Government will allocate the necessary funding for hospital improvements and other infrastructure projects. The potential of VAT savings will increasingly become a major consideration for trusts up and down the country. Capital investment is always to be welcomed and it is long overdue. Whether we think we will have 40 or six new hospitals, my sympathies are with the finance directors and managers in trusts who are faced with the task of maximising these investments, and managing the competing interests of recruiting and retaining staff, developing integrated local health systems and securing local public trust in their plans. It is my belief that the underlying problem here is that the priorities of Her Majesty’s Revenue and Customs and the Department of Health and Social Care are not in alignment.​

The problem manifests itself in a number of ways. First, a decade of underinvestment in our health service has led to NHS trusts desperately trying to recover whatever finances might be possible. Some of the VAT rules and debates go back decades. I hope the Minister does not rise to say that the last Labour Government used rules to involve the private sector and are responsible for some of this, and I respond by saying that it all started under Margaret Thatcher’s outsourcing, and we simply do not help anyone. I hope we can be more helpful than that. That was the last comment I had back, so I am just stemming that off at the pass.

The real explosion in this issue came from the direction of the coalition Government and the creation of contracted-out services regulations. The HMRC manual “VAT Government and Public Bodies”, from 2012, states:

“Government departments and health authorities have been encouraged to contract out services to the private sector which would have traditionally been performed in-house”—

over many decades.—

“It is recognised that many of these services would be subject to VAT and where they were acquired for ‘non-business’ purposes, the non-reclaimable VAT could act as a disincentive to contracting-out.”

That was then the policy of the Government. The manual continues:

“It was therefore decided to compensate government departments and health authorities by a direct refund mechanism, which is provided for in section 41(3) of the VAT Act 1994. Under this provision, the Treasury issues a Direction, commonly known as the ‘Contracting Out Direction’ which lists both the government departments and health authorities that are eligible to claim refunds of VAT, and the services on which VAT can be refunded.”

For lay people, myself included, that in essence means that under these regulations full VAT could be recovered on the cost of a managed service which provided premises that could be used for delivering healthcare. Of course, the private sector was pleased, as it meant it could now, as it saw it, compete on a level playing field with the public sector. But really we should view any tax breaks or loopholes with extreme suspicion, as they lead to reduced revenue for the Exchequer. There should always be a compelling public interest for any tax breaks or loopholes. After this direction and as austerity has bitten, more and more complex arrangements have been set up.

Following the OTS 2017 report, I am sure many in the accounting departments across the public sector were relieved to hear last year’s spring statement, when the then Chancellor announced a consultation on VAT in the public sector. This could mean a potential reform to VAT refund rules to reduce administration and improve public sector productivity. However, concerningly, the language of the spring statement, and the background to it, appear to suggest a widening of VAT refunds for those engaged in services—that, again, is reducing the amount of VAT paid by public sector contractors back to the Treasury. I am worried that the Treasury are going to make the situation worse.

My good colleague in the other place, Lord Hunt, followed up on the whereabouts of the review in October, when he asked for an update on the review’s progress. He was told by the Earl of Courtown to expect a policy paper for public consultation “in the coming months”. I know we have all been busy, but the world awaits and it ​would be helpful if the Minister provided the House with an update on that review, either tonight or in writing afterwards.

The area of VAT avoidance that has attracted a great deal of attention, and that myself and many colleagues—including my hon. Friend the Member for Blaydon (Liz Twist)—visited the Treasury to talk about last year, is the establishment of wholly owned companies in NHS trusts. Such companies can be seen up and down the country, from Northumberland to Yeovil. They vary greatly between those that try to remain part of the NHS and those that position themselves as separate corporate businesses only loosely connected to patients and the public. Most are set up to deliver a full range of facilities management services—including cleaning, catering, porters and security—and then charge the parent trust for this managed service on a private finance initiative-style unitary fee basis.

We have heard that, to avoid charges of tax avoidance, which created a degree of media discussion, the new arrangements are supposed to be better from a service-delivery point of view. Ostensibly, they are solving problems with estates and facilities management and how staff are managed, but there is no evidence of that. In every case, almost all the benefits, some of which are considerable financial benefits for the trust, appear to come from tax changes, not service improvements. Many of the schemes have resulted in thousands of NHS staff being taken out of the NHS and transferred against their will into wholly owned subsidiaries. This increases fragmentation, and there are examples of companies falling out with their parent trust. There are also arguments about which organisation is responsible for what and who pays.

Far worse is that in some cases the use of a separate company is used to undermine national agreements on terms and conditions. Around 50 such proposals have been progressed or are in the pipeline, and it is highly worrying that they were advanced in secret, without consultation with patients or the workforce involved. When freedom of information requests were made for access to the business cases that sought to justify the changes, trade unions and others were denied access, with claims that the information was commercial and confidential.

Just this week, The Pharmaceutical Journal reported that 34% of trusts had outsourced their pharmacy service to a commercial firm and 16% have created wholly owned subsidiaries. The practice is now widespread. Despite that, the recent examples at the Bradford Trust and the Frimley Health Trust have been vigorously opposed, particularly by Unison, and it appears that both proposed schemes have been stopped. That is good news for thousands of low-paid staff who wish to remain NHS employees.

Thanks to the considerable pressure put on NHS Improvement, trusts must now in effect ask for permission before they create a subsidiary company, although far from being a device to prevent the practice, the seeking of permission appears more like a scheme to embellish some badly written business cases so that the changes can go ahead with a veneer of justification. Under some pressure, that process is being reviewed.​

Although in the short term it appears that individual trusts will gain through tax advantages offered by the wholly owned companies, other trusts will not, and it means less VAT for the Treasury. But the Treasury seems unconcerned about the lost income. The practice is not a strategic, collaborative or positive solution to the problems that trusts face, and it is not about better employment. The NHS has agreed national terms and conditions for a good reason: because overall it works. All these schemes try to undermine the national agreements and offer staff less favourable terms to save money.

Having two-tier workforces is not a good way to progress. A few years ago, I made that point successfully in my own area of Bristol. The North Bristol NHS Trust, which was at the time under considerable financial pressure, was considering adopting a wholly owned company but, following local discussions, including with Unison, it recognised that in the local, highly competitive market for staff, at a time when the trust needed to start to collaborate on service development, it needed not to outsource. The creation of a second and third-tier workforce made no sense operationally and gave the wrong messages to staff and the public about valuing the all-important workforce across the entire Bristol health economy, so the trust did not do it.

As I touched on in my opening remarks, the controversy over VAT and how it applies in the NHS is relevant to infrastructure investment, because the temptation for the trusts set to benefit from the new capital—I accept that there is new capital, and that is good—will be to avoid paying VAT to reduce significantly the direct ongoing costs. That is why it is so important that the Government give careful consideration to how the investment is going to be made.

I believe the choices made by the Government on this issue will reflect how well they understand both the importance of the NHS estate itself, as part of the health ecosystem, and the direction of the long-term plan. I cannot emphasise enough—and I do think hon. Members understand this—that capital is not a technical, dry subject, but is crucial to the delivery of quality health care. It is not a burden on the system. It is time for us all to show we understand that we need a joined-up strategy and proper investment.

The thing I kept at the forefront of my mind as an NHS manger, and do so now as a local representative, is that the health service is wholly funded by the taxpayer, and the public have a great attachment to people and place when engaging with healthcare. Buildings are so much more than a pile of bricks of which to sweat the assets, or empty vessels to lease for maximum return. Buildings really are a physical manifestation of local people’s love for and connection to their local health service. Local people are not over-concerned with how services are developed, but they do not expect their health service to behave in such a way as to constantly try to exploit tax loopholes or penalise staff.

For 15 years or so I have been a supporter of the concept of place-based commissioning, by which I mean local collaboration across the public sector, making good use of the publicly owned estate to deliver quality health services and maximising the value of the taxpayer’s pound. Place-based commissioning has been the direction of travel for some time. It was knocked off course by ​the Health and Social Care Act 2012, but there is hope of getting it back on track once the long-term plan is in place.

I understand that the setting up of a subsidiary might make sense in the short term for individual trusts, but it makes no sense for the wider health economy or the whole NHS. We must move from a competitive, short-term, market-driven approach at a micro level to a collaborative approach focused on overall gains. The logic of the VAT exploitation and WOCs practice is based on the old idea of trusts having autonomy, behaving like businesses and competing, but this is out of date and directly at odds with the NHS plan, which is built around place-based solutions like sustainability and transformation partnerships and integrated care schemes. On the contrary, the fundamental principle underpinning these initiatives and the Government’s own strategy is much greater collaboration across the system, which absolutely includes the use of buildings and any capital investment.

Another example of what those running the health service are trying to grapple with is GP commissioning and the new primary care networks. One of my last jobs before coming to this place was running a GP commissioning group, so I understand how difficult it is to get practices to work together and align their businesses. Last summer the NHS published a document called “The Primary Care Network Contract DES and VAT”, referring to the way in which the health service funds these proposals. The document sought to give guidance about VAT in the new primary care networks. The author goes to some pains to set out over several pages what NHS England “expects” will be the best approach—and then comes the following caveat:

“Although we anticipate the VAT treatment to follow the above analysis it is not straightforward. Practices should note that HM Revenue & Customs has not agreed the position described in this document and that they are the authority responsible for agreeing, administering and collecting VAT.”

If the Government and NHS England are publishing guidance on how to set up these new organisations without really knowing how HMRC is going to treat them, how on earth can we expect people in the frontline to develop good services?

Let me mention another issue, which is local to my constituents and which I have been working on for some time: GP employment status. For the last five years, HMRC has been reviewing the employment status of GPs who provide NHS out-of-hours services, which are now called integrated urgent care services. During this period, demand for GP services has risen and the need identified by NHS England for a substantial—that is, 5,000-plus—increase in the number of GPs has not yet been met with whole-time equivalent resourcing. Based on arrangements in place since the formation of the NHS, GPs have continued to work on a self-employed basis, and this remains the desired option for many of them. This has been the subject of some political debate over a number of years, but it is the position as people understand it.

BrisDoc is a local GP organisation based in my constituency that provides urgent care services to the NHS. It has been faced with five years of uncertainty regarding its workforce because HMRC does not accept the legitimacy of independent GPs working on a self-employed basis, even though this correctly reflects the way services are contracted based on professional and ​legal advice. How they are funded is a separate debate, but if HMRC changed GPs’ status, it would increase the risk that GPs would not be willing to work and would increase the cost to the NHS. Both of these have a negative impact on NHS services, reducing GP capacity at a time when we need more, and costing more, which will ultimately lead to a greater cost for the Treasury.

The priority has to be on patient safety and care, and the provider, BrisDoc, has continued to fight for this focus in order to maintain the best possible level of GP availability. However, HMRC states that its focus is simply on “employment status” and not any wider implications of any change, whereas NHS England indicates that it cannot get involved with determining employment status for GPs, who are an essential part of the NHS workforce. This leaves BrisDoc vulnerable to financial and workforce loss while doing everything possible to maintain the service. Its plea, and my plea on behalf of my constituents, is this: can the overall strategy for the GP workforce be reviewed to ensure that the key priorities and objectives are aligned with regard to any change in employment status? It is unacceptable nonsense for it to spend five years between the two Government Departments. Will the Minister be willing to meet me and BrisDoc to better understand the problem?

I hope that I have impressed on the Minister not only the preposterous nature of this VAT problem but how critical it is that we sort this loophole out now through proper consultation with the NHS and an urgent publication of the VAT review. Finance directors in particular need the support to make decisions that align with the strategic vision of the long-term plan, not that are at odds with it. To do this, the guidance from HMRC and the policies of the Department of Health and Social Care must be joined up. If the Government are, as they have indicated, supportive of the strategic direction of the NHS plan, then this must mean supporting local health economies to flourish through the collaborative partnerships integral to STPs and integrated care systems. They simply cannot work if trusts, and other delivery partners, are in competition with each other.

After a decade of fairly imprudent underinvestment and failing policy, we really are at a crossroads, and we need to get this right. If we can level the playing field for all trusts through proper funding, and consistent, sensible VAT rules that do not divert time and effort from the objectives of the trusts to serve their local patient population, we could have every reason to be positive about the potential of local place-based commissioning for success.