While the VAT saving implications of the model are clear, it is vital that local authorities understand both the risks and the many knock on effects of an agency model before adoption. This is more important than ever with the new procurement rules which came into force on 24 February 2025. DWF have the skills and experience to guide you through the issues.
In March 2023, HMRC published a Policy Paper, confirming (broadly) that the operation of leisure centres by local authorities is "non-business". This means that local authorities could reclaim VAT on their costs without charging VAT to their customers. See our earlier article.
This advantageous VAT position is a clear benefit to a sector suffering from increased costs and lifecycle expenditure. The problem is that it is only available where an authority runs a centre itself. Recent figures suggest that less than a quarter of authorities actually do so.
One much discussed attempt to square that circle has been the so-called "agency model". This involved a private provider operating a leisure centre as the "agent" of the local authority.
In this article, we look at what the agency model is and some issues that can arise in implementing such a model, including consideration of the Procurement Act 2023 ("PA 2023"), which came into force on 24 February 2025.
What is the Agency Model
The "agency model" relies on standard VAT agency rules to treat the local authority as running the leisure centres despite day to day management being outsources to a separate operator.
As many operators are charitable trusts that would otherwise make VAT exempt supplies (which would not allow VAT incurred on costs to be recovered), the "agency model" is intended to save a significant amount of otherwise irrecoverable VAT.
Helpfully, there is a VAT memorandum of understanding agreed by HMRC in 2007 that specifically provides for the possibility of leisure centres being outsourced via agency arrangements.
Therefore, at first sight, the arrangement looks like an easy win and both our own experience and publicly available information suggests that, over the last year, adoption of the "agency model" has accelerated in the sector.
There is, however, no clear guidance from HMRC on how they see the tribunal decisions which prompted the HMRC 2023 policy paper applying to the "agency model".
Further, there are still a number of challenges and uncertainties regarding how the "agency model" should be set up and operated.
Compatibility of normal operating structures with VAT agency
Most leisure operating contracts between local authorities and operators are based on the Sports England Leisure Operating Contract template (the "LOC").
The LOC assumes a normal concession arrangement, with a peppercorn lease granted by the local authority to the operator. This assumption underpins much of the commercial operation of the LOC, particularly with respect to risk allocation and profit sharing.
The "agency model" however, operates on an entirely different basis. Trying to use the LOC as the model for an agency contract, therefore, requires a detailed review and significant amendment.
VAT Agency and day to day operation
HMRC will generally look to the reality of any arrangements to determine if an an agency actually exists. It is, therefore, important that the parties actually understand how the arrangement works and that marketing, VAT invoicing, reporting and other day-to-day activity reflect ongoing agency arrangements.
This is particularly important where there is an attempt to convert an existing concession arrangement into an agency arrangement. A crucial but underappreciated piece of HMRC guidance reads:
"Beware, in particular, of agreements which have been recently drawn up in an attempt to portray a long-standing relationship as a newly formed agency agreement. When considering these new ‘agency’ agreements, your first question should always be, does this reflect the past? Have there been any changes in working practice, as opposed, for example, to mere changes in the status of personnel?"
All too often, we see the "agency model" promoted on the basis that nothing needs to change 'on the ground'. This is not the case.
Responsibility of the local authority
The whole basis of the agency model is that the local authority is (at least for VAT purposes) providing services direct to customers.
While most of the local authority's leisure centre activity should be "non-business", not all will be. The local authority will therefore need sufficient information to be able to complete its VAT returns and will have to consider the effect of the agency model on its own VAT partial exemption calculations.
Therefore, appropriate information protocols will need to be in place to manage this risk and ensure that the arrangements can be properly operated.
Business Rates
An "agency model" will generally not involve granting a lease or any significant property interest to the operator acting as agent as this is inconsistent with an agency.
However, it is important not to forget that one of the main benefits, at least historically, of local authorities outsourcing leisure centre services to charitable trusts, was the business rates benefit to such arrangements.
Broadly, charities benefit from an 80% business rates reduction and application may be made for full discretionary business rates relief.
However, neither charities relief, nor discretionary business rates relief can apply to the local authority themselves, and charities relief at least cannot apply to any non-charitable service provider.
Therefore, any agency model should ensure that the charitable operator is the "occupier" for business rates purposes and this will need to be properly considered.
Procurement
Historically, procurements have tended to be conducted under either the Public Contracts Regulations 2015 ("PCRs") or the Concessions Contracts Regulations 2016 ("CCRs"). All future procurements will be conducted under PA 2023.
Previously, there may have been some debate as to which regime should apply to the procurement (PCRs or CCRs). However, the standard form LOC was technically outside of the application of of the PCRs; as a result the modification and remedies regimes, under the PCRs, would arguably not apply to a leisure operating concession.
Which regime applied (or should have applied) to a leisure centre concession remains an important consideration, as the transitional provisions to the PA 2023 confirms that the previous regimes will continue to apply to such historic procurements.
Therefore, any change of existing arrangements to an agency model will need careful consideration from a procurement perspective. There is a risk that an agency model where the income does not belong to the Operator, the Operator does not necessarily get exposed to the commercial risks in the same manner or instead receives what might be more akin to a management fee, may be more difficult to safely implement.
The position has changed for new procurements from 24 February 2025 as all new procurements will fall under the PA 2023. However, modifying a concession contract to be an agency arrangement is likely to be subject to similar considerations as those under the PCRs.
Therefore, if an agency model is thought desirable, it is likely to be better for it to be raised as part of an initial procurement if possible. Further, it may be difficult for some operators to adopt the agency model.
If you would like to discuss any consequences of the matters discussed in this article, please do not hesitate to contact James Lupton, Alex Tolcher or your usual DWF contact.
