The cost to the FE sector of “unfair” rules which mean colleges have to pay tax on their spending for education is pound;221 million and is set to rise by over 10 per cent, a survey has revealed.

Members of the Association of Colleges (AoC) each reported an average annual VAT bill of pound;600,000 despite other 16-19 educational institutions being exempt.

With January’s 2.5 per cent rise in VAT, the total bill for colleges is likely to increase by about pound;30 million.

Colleges argue that the VAT burden, equivalent to about 3 per cent of their total spending, constitutes a further drain on finances at a time when budgets are being reduced by millions. The total tax bill equates to the turnover of some eight general FE colleges.

AoC assistant chief executive Julian Gravatt said: “It is the complexity as well as the cost. But their funding has been capped at a time when costs, including VAT, are going up.”

Sixth-form colleges are aggrieved that they are in close competition with schools and academies which automatically reclaim the full cost of VAT. Colleges can only claim back VAT in certain circumstances, such as on the costs of new buildings which are used by adults for less than 5 per cent of the time.

Many survey respondents pointed to the inconsistency of colleges’ recent reclassification as part of central Government under spending and borrowing rules, while being regarded as independent for taxation purposes.

General FE colleges say their situation is particularly complex. Changes to adult fees, such as reducing entitlements for free courses, increase the VAT burden because more provision is deemed “business” rather than charitable.

“The VAT situation in colleges is absurd,” one college said. “Approximately 90 per cent of our funding comes from Government. After incurring time and expense in managing VAT, which can be complicated in colleges and carries penalties if we get it wrong, we pay pound;400,000 back to another Government agency. VAT rules are stopping real benefits and value- for-money improvements.”

HM Revenue and Customs and the Department for Business, Innovation and Skills (BIS) argue that their hands are tied because of European Union agreements on how VAT should be applied. BIS said it meant there were few opportunities to eliminate the VAT anomaly without compromising colleges’ independence.

A Department for Education spokeswoman said a proposed VAT refund for academies was intended to “ensure that schools converting to academy status are not put at a disadvantage, and will fund existing academies’ VAT costs in a more efficient way.”

She added: “There are currently no plans to extend this to colleges.”

• Original headline: Revealed: pound;221m cost of `unfair’ VAT anomaly