Formula-Based Government Education Funding as Third-Party Consideration Creating a VAT “Direct Link”

1. Introduction

This appeal concerns whether publicly-funded further education delivered by Colchester Institute Corporation (“CIC”), an “eligible body” under UK VAT education provisions, was supplied “for consideration” for EU VAT purposes where the money came not from students but from two state funding bodies: the Education Funding Agency (“EFA”) and the Skills Funding Agency (“SFA”) (together, the “Funding Agencies”).

The VAT period was 1 November 2015 to 31 January 2016. CIC delivered vocational education and training to students, some of whom were fee-paying and others who were fully funded (and therefore not charged fees) because CIC received EFA/SFA funding under standard-form annual funding agreements made under the Secretary of State’s statutory powers (Education Act 2002, s.14–s.16).

The central issue was whether the EFA/SFA payments were (i) general subsidies for CIC’s activities (not consideration), or (ii) third-party consideration paid “in return for” identifiable supplies of education/training to eligible students (consideration), thereby satisfying Article 2(1) PVD and the EU law requirement of a “direct link” (reciprocity).

Procedurally, HMRC challenged two Upper Tribunal decisions: Colchester Institute Corporation v HMRC [2020] UKUT 368 (TCC) (“CIC UT 2020”) and [2024] UKUT 397 (“CIC UT 2024”). HMRC advanced two grounds: (1) alleged misreading of Case C-151/13 Le Rayon d'Or Sarl v Ministre de l'Economie et des Finances of 27 March 2014 (“Rayon d'Or”); and (2) alleged misapplication of the “direct link” test.

2. Summary of the Judgment

The Court of Appeal (Foxton LJ, with Arnold LJ and Asplin LJ concurring) dismissed HMRC’s appeal.

• Ground 1: The Court held the UT in CIC UT 2020 went too far in saying Rayon d'Or was “not a case involving a Kennemer supply at all”, because the CJEU’s emphasis on “permanent availability” drew on Case C-174/00 Kennemer Golf and Country Club v Staatssecretaris van Financiën [2002] QB 1252. However, the Court also held Rayon d'Or was not determinative in CIC’s favour and still provided “considerable support” for CIC’s case.
• Ground 2: The Court held that, on the proper multi-factorial analysis with the funding agreements as the starting point, the EFA/SFA payments were made in return for CIC delivering approved education/training services to eligible students. There was sufficient reciprocity/direct link even though payments were formula-based, “lagged” (proxy) and not tailored to each student/course ex ante.

Because HMRC had to succeed on both grounds to succeed overall, and Ground 2 failed, the appeal was dismissed.

3. Analysis

3.1 Precedents Cited

A. The foundational “direct link”/reciprocity line

• Case C-16/93 R J Tolsma v Inspecteur der Omzetbelasting Leeuwarden [1994] STC 509 (“Tolsma”)
  Tolsma was used for the orthodox proposition that VAT requires a legal relationship with reciprocal performance, producing a “direct link” between service and payment. HMRC also relied on Tolsma to argue a “stipulated price” requirement. The Court rejected HMRC’s reading: “stipulated” in Tolsma was taken as “required” (a payment obligation), not as demanding a separate, recipient-specific price for each instance of supply.
• Wakefield College v HMRC [2018] EWCA Civ 952
  This domestic Court of Appeal authority was central in articulating reciprocity: the “direct link” means reciprocal performance under a legal relationship. It also confirmed consideration need not reflect full value. The Court treated this as consistent with the EU case-law framework and used it to frame the dispute as: are the Funding Agencies paying for supplies, or merely funding activity subject to conditions?
• Case 102/86 Apple and Pear Development Council v Commissioners of Customs and Excise [1988] 2 CMLR 394
  Apple and Pear was HMRC’s counter-example: compulsory levies funding an industry-wide body lacked direct link because services were for the common interest, not individual reciprocal benefits. The Court distinguished CIC’s position: CIC delivered the same education services to identified students as it did to fee-paying students; the funding substituted for the fee rather than financing diffuse, collective benefits.
• Case 154/80 Cöoeperatieve Aardappelenbewaarplaats [1981] ECR 445 and Case 230/87 Naturally Yours Cosmetics [1988] ECR 6365
  These authorities were cited (via Tolsma) as part of the standard doctrinal chain establishing the “direct link” requirement and the concept of consideration as the basis of assessment.

B. Identifying the “service” where payments are periodic/flat-rate: Kennemer and its extensions

• Case C-174/00 Kennemer Golf and Country Club v Staatssecretaris van Financiën [2002] QB 1252
  Kennemer establishes that annual subscriptions can be consideration even when not tied to actual usage, because the “service” can be “making available, on a permanent basis” facilities/advantages. This mattered in two ways:
  • It supplied the analytical tool for flat-rate payments: the service need not be a single, time-stamped performance.
  • It became pivotal in construing Rayon d'Or, where the CJEU referred to “permanent availability” of healthcare.
• Case C-151/13 Le Rayon d'Or Sarl v Ministre de l'Economie et des Finances of 27 March 2014 (“Rayon d'Or”)
  The UT had treated Rayon d'Or as effectively decisive. The Court corrected that: Rayon d'Or had Kennemer-type features (in an extended sense) because the CJEU relied on “permanent availability” to meet care needs, meaning the direct link did not require matching payment to personalised services at specific times. However, the Court also held Rayon d'Or was not limited to “availability” alone; it also supports the broader proposition that lump-sum/formula payments can be consideration where determined in advance on well-established criteria.
• Asparuhovo Lake Investment Company OOD v Direktsia 'Obzhalvane i danachno-osiguritelna praktika' Varna, (Case C-463/14), 3 September 2015 (“ALIC”)
  ALIC was used to show the CJEU itself treated Rayon d'Or as involving a permanent-availability model: fixed payment relates to a supply “irrespective of the number of services provided and received”. The Court used this as part of its Ground 1 correction to the UT’s characterisation.
• Case C-174/14 Saudaçor – Sociedade Gestora de Recursos e Equipamentos da Saúde dos Açores SA v Fazenda Pública [2016] STC 681 (“Saudaçor”)
  Saudaçor reinforced that permanent and continuous services can be supplied for a flat-rate payment determined in advance by well-established criteria; the Court highlighted that Saudaçor treated Rayon d'Or as supporting this broader point beyond a strict Kennemer-style “availability” supply. It supported CIC by legitimising formula-based, operating-cost-covering compensation as consideration where the contract frames it as such.

C. Third-party consideration and why it does not break the “direct link”

• Dixons Retail plc v Revenue and Customs Commissioners Case C-494/12, judgment of 21 November 2013
  Dixons confirms Article 73 PVD allows consideration to be paid by a third party: payment need not be obtained directly from the service recipient. This underpinned the Court’s acceptance that EFA/SFA payments can be consideration for education supplied to students.
• Revenue and Customs Commissioners v Airtours Holidays Transport Ltd [2016] UKSC 21
  Airtours was used to emphasise that reciprocity is assessed from the supplier’s perspective and that requiring the recipient to be legally liable would enable VAT avoidance by structuring. The Court invoked Airtours to reject HMRC’s attempt to impose special restrictions on apportionment/consideration where a third party pays.

D. Distinguishing “price-linked” subsidies from general funding: the key boundary cases

• South African Tourist Board v The Commissioners for Her Majesty's Revenue and Customs [2014] UKUT 280 (TCC)
  This was HMRC’s principal domestic analogue. The UT there held government funding was not consideration where it enabled a statutory body to perform its function and any government benefit was incidental; the “targets” were oversight conditions, not mutual exchange. The Court of Appeal treated the reasoning as sound but found CIC was different on the contracts and economic reality: CIC provided the same service to both funded and fee-paying students, and the agreements were framed as payment “in consideration” for delivering defined “Services/Provision” to “Students/Learners”.
• Balgarska natsionalna televizia v Direktor na Direktsia 'Obzhalvane i danachno-osiguritelna praktika' – Sofia pri Tsentralno upravlenie na NAP C-21/20, 16 September 2021 (“Balgarska”)
  Cited in relation to (i) HMRC’s “price stipulated” argument (rejected as misconceived), and (ii) to illustrate when a state subsidy is not consideration: no relationship analogous to insurer/insured and services benefit all potential viewers; subsidy is not calculated by reference to identifiable users. The Court used Balgarska to show why “diffuse beneficiary” models differ from the present case with identifiable enrolled students.
• Dyrektor Krajowej Informacji Skarbowej v PSA (Case C-615/23) (“PSA”), opinion of 13 February 2025 and Case C-615/23, judgment of 8 May 2025
  PSA (public transport compensation) crystallised the modern subsidy boundary: compensation benefiting all potential passengers and calculated without reference to number/identity of users lacks direct link. The Court of Appeal used PSA to (a) refine how Rayon d'Or is distinguished (identifiable recipients; criteria set in advance), and (b) underscore that CIC’s position is on the “price-linked” side because the agreements, data reporting (ILR), and formulae tied payment to delivered student provision (even by proxy).
• Case C-184/00 Office des Produits Wallons ASBL v Belgium [2003] STC 1100
  This authority was cited to confirm that public-body grants/subsidies can, in principle, be consideration under VAT; the question is factual/legal characterisation, not the public nature of the payer.

E. “Stipulation”, ex post fixing, and apportionment of lump sums

• EQ v Administration de l'Enregistrement des Domaines et da la TVA Case C-846 19, judgment of 15 April 2021 (“EQ”)
  EQ demonstrated that remuneration may be fixed ex post yet still be “determined in advance” where criteria are well-established and procedures foreseeable. The Court used EQ to rebut HMRC’s insistence on an ex ante, per-supply price stipulation.
• Marks and Spencer plc v HMRC [2019] UKUT 182 (TCC), Field Fisher Waterhouse LLP v Revenue and Customs Commissioners C-391/11, [2013] STC 136, and Revenue & Customs Commissioners v KE Entertainments Ltd [2020] UKSC 28
  These cases were cited for the uncontroversial VAT proposition that lump-sum consideration covering multiple supplies can be apportioned, sometimes dependent on later events. The Court used them to reject any special rule forbidding apportionment merely because the payer is a third party (a point HMRC suggested without authority).
• Case C-182/17 Nagyszénás Településszolgáltatási Nonprofit Kft v Appeals division of the National Tax and Customs Authority, Hungary, judgment of 22 February 2018 (with reference also to judgment of 29 October 2015, Saudaçor, C-174/14)
  This reinforced that flat-rate annual compensation does not of itself negate direct link, even with adjustment/reimbursement clauses and even if below market value, provided the compensation is determined in advance using criteria sufficient to cover operating costs. It supported the Court’s acceptance that EFA/SFA formula funding can be consideration.

3.2 Legal Reasoning

(i) Ground 1: Correcting the place of Rayon d'Or—important, but not decisive

The Court held the UT overstated matters by excluding Kennemer-type reasoning from Rayon d'Or. The CJEU in Rayon d'Or expressly relied on “permanent availability” and cited Kennemer; later CJEU treatments in ALIC and PSA were consistent with that reading. Accordingly, the UT’s assertion that Rayon d'Or was “not a case involving a Kennemer supply at all” was legally unsound.

However, HMRC’s larger ambition—downgrading Rayon d'Or as providing no support to CIC—also failed. The Court stressed that Rayon d'Or supports a broader principle: lack of personalised/time-specific services and lump-sum payment do not preclude a direct link where the amount is determined in advance using well-established criteria. That broader reading was corroborated by Saudaçor and EQ.

Crucially, the Court held Rayon d'Or did not “determine” CIC’s case because there were possible factual/legal distinctions (e.g., insurer/insured relationship; identifiable recipients). This set the stage: the real answer lay in the bespoke analysis of the EFA/SFA agreements under the general “direct link” test (Ground 2).

(ii) Ground 2: The “direct link” satisfied—contractual reciprocity plus output-linked funding architecture

The Court formulated the core question as a characterisation problem: were the Funding Agencies (a) funding CIC’s activities subject to conditions, or (b) paying for supplies of education by CIC to eligible students?

Applying the “multi-factorial” approach (as described in South African Tourist Board v The Commissioners for Her Majesty's Revenue and Customs [2014] UKUT 280 (TCC)), the Court treated the agreements as the “appropriate starting point”. On the language and structure of the EFA “Conditions of Funding Agreement” and the SFA “Financial Memorandum”, the Court found strong indicators of reciprocal exchange:

• Express “in consideration of” drafting (notably EFA clause 4.1), echoing the significance attributed to such language in Rayon d'Or and Saudaçor.
• Defined “Services/Provision” to be delivered, and “Students/Learners” as those to whom CIC must deliver them—making the supply legible and specific.
• Funding restricted to approved-qualification courses, aligning payment with a defined class of supplies.
• Funding calculated by formulae with “per student” architecture and hours/cost weightings—imperfect proxies, but proxies for CIC’s outputs, not merely its existence.
• Clawback/recovery mechanisms for under-delivery (and other audit-related recovery powers), evidencing that payment was conditional on delivery in a way consistent with payment-for-output, not mere general grant.
• Monthly Individualised Learning Record (“ILR”) reporting on each individual student—supporting identifiability and traceability of the supplies delivered.

The Court also relied on the economic coherence shown by CIC’s “Receipts”: both funded and unfunded students were treated as receiving the same course supplies; the difference was the “waiver” for those whose course fee was met by funding. This strongly supported the “third-party consideration substituting for the fee” analysis, and distinguished diffuse-benefit cases like Apple and Pear and PSA/Balgarska.

HMRC’s objections—autonomy over course choice; “lagged” numbers; inability to tie each pound to each student; absence of a contract between Funding Agencies and students—were all rejected as insufficient to break reciprocity. The Court treated lagged numbers and formulae as administratively convenient means to fund in advance where enrolment is not yet known, rather than as evidence of “general subsidy”. Nor did the Court accept any legal requirement of a payer-recipient legal relationship in a three-party scenario.

Finally, the Court accepted that not every component of the funding necessarily had to be consideration for course supplies (e.g. “Disadvantage Funding”). It was enough that a substantial part was; apportionment principles could be used.

3.3 Impact

• Education funding and VAT business activity: The judgment reinforces that where funding agreements are drafted and operated as payment for delivered education outputs to identified learners, the funding is capable of being third-party consideration. This has practical consequences for VAT characterisation of publicly-funded provision (and downstream issues such as attribution of input tax, partial exemption, and “business/non-business” boundaries).
• Clarification on “stipulated price” arguments: The Court’s rejection of HMRC’s “stipulation” thesis (as requiring per-recipient/per-supply price specification) makes it harder to deny consideration merely because the remuneration is formula-based, paid in tranches, or reconciled later.
• Subsidy boundary sharpened: By contrasting CIC with PSA and Balgarska, the Court underlines two recurring differentiators:
  • Whether services are delivered to identifiable recipients (enrolled students) rather than all potential beneficiaries (potential passengers/viewers).
  • Whether payment is calculated by reference (even proxy reference) to the service output delivered, rather than compensating losses ex post without user linkage.
• Drafting and administration matter: The emphasis on contract terms (“in consideration of”), output metrics (ILR), and recovery mechanisms signals that public bodies and providers should expect VAT outcomes to follow the legal/economic architecture they adopt.

4. Complex Concepts Simplified

• “Supply of services for consideration”: VAT applies only where a service is supplied in exchange for something of value (money or money’s worth). The exchange need not be at market value.
• “Direct link” / “reciprocity”: There must be a sufficiently close exchange relationship: the payment is made because the service is (or will be) supplied, and the service is supplied because the payment is (or will be) made.
• Three-party consideration: The person paying (here, EFA/SFA) can be different from the person receiving the service (the student). That does not prevent the payment being consideration.
• Kennemer-type supply (“making available”): Sometimes the “service” is not each act of performance, but the ongoing right/availability to receive benefits (e.g., a club’s facilities; in Rayon d'Or, healthcare availability as required). This helps explain why flat fees can still be consideration.
• General subsidy vs price-linked subsidy: A general subsidy supports an organisation’s activities without being paid in exchange for specific supplies (no VAT consideration). A price-linked subsidy is paid in exchange for, or by reference to, defined supplies (can be consideration).
• “Lagged” student numbers and formula funding: Funding is calculated using prior-year or projected data as a proxy to pay in advance; later reconciliation/clawback mechanisms can preserve the link to actual delivery without requiring perfect matching to each student from the outset.

5. Conclusion

The Court of Appeal confirms that EFA/SFA funding to a further education college can constitute third-party consideration for VAT purposes where the funding agreements, operational controls, and funding formulae show reciprocal exchange for the delivery of approved education/training to identifiable students. It also clarifies that EU VAT law does not require per-student/per-course “stipulated” prices to establish a direct link: lump-sum or formula-based funding can suffice, particularly when calculated and administered by reference to outputs and subject to adjustment/clawback.

While correcting the UT’s overstatement about Rayon d'Or and Kennemer, the Court ultimately grounds the result in a contract-led, multi-factorial reciprocity analysis—providing a structured approach for future disputes at the boundary between “payment for supplies” and “general public funding”.