Taxing times for hospitals if VAT man has his way

New VAT rules could deprive NHS trusts of pounds 100m, exacerbating the most severe financial crisis in the service for years. Trusts are angry that changes to the system have been imposed without notice, destroying carefully worked out budgets, and say they will lead to ward closures and redundancies.

Until now Customs & Excise has allowed NHS trusts a period of grace to reclaim VAT on contracted-out services. But with immediate effect, trusts can now obtain refunds only in the current financial year, losing them unclaimed refunds from previous years.

A statement from Customs & Excise says: "Existing rules have been restated which apply to all government departments, including health authorities. VAT recovery on contracted-out services is confined to a current-year basis because Treasury funding will have taken account of non-recoverable VAT for earlier years. In the past some flexibility has been allowed in particular circumstances where an NHS body has been unable to identify the tax involved."

The removal of this flexibility has ended what is in effect double funding, argues Customs & Excise. The NHS Trust Federation says this interpretation is disingenuous, and ignores the fact that trusts are losing funding as a result. "Money is now going back to the Treasury, which may be technically correct, but the need is in the NHS," says a spokesman for the federation. "This could have a dire effect on trusts, which are walking a financial tightrope at the moment."

A spokeswoman for Customs says that the removal of the flexibility does not represent a change of policy. Richard Watson, head of VAT practice at Price Waterhouse, says: "There is a considerable amount of double-think going on in Customs & Excise if they think this is not a new policy. Almost as a matter of course trusts have made claims going back a number of years because their accounting systems cannot cope with claiming on a contemporaneous basis."

Richard Emms, a senior manager at Deloitte & Touche, agrees. "Not only have Customs decided to change the rules with immediate effect, they will not even allow a transition period for NHS trusts to get their VAT claims up to date. They are penalising organisations without the specialist resources to deal with the complex VAT recovery rules. NHS trusts are under pressure to deliver patient care, and should not have to divert tight financial resources."

An NHS VAT forum has been established by trusts to protest at the rules, which were only communicated through an annual letter to trusts last month. The forum calculates the cost to trusts will be about pounds 100m, which will have to be found through ward and bed closures, and redundancies.

Stiffening the VAT rules for trusts is just one of a number of hard-line decisions taken by Customs & Excise in the run-up to what is expected to be a tough budget. Customs has also announced a blitz on traders who falsely claim VAT registration, and a new three-year limit on rebates for overpaid VAT which will hit businesses and local authorities hard.

Councils will be even harder hit by other changes to the operation of VAT following a test case earlier this year involving the London borough of Haringey. Until now, local authorities have operated a less rigorous VAT accounting system than those of businesses, because councils could reclaim VAT on exempt activities where this amounted to no more than 5 per cent of the total VAT being recovered.

Ernst & Young calculates that on a conservative estimate the new rules will lead to an additional annual pounds 150m VAT contribution from local authorities