For years, VAT has been the proverbial elephant in the room for the sector in the UK: a complex and often overlooked area that impacts governance models, trading income, and capital investment decisions.

Changes to UK government (HMRC) VAT rules in March 2023 (www.hcmmag.com/nickburrows) have fundamentally shifted the landscape, particularly for local authorities and not-for-profit leisure operators. This shift has brought something called the Agency Agreement Model into sharper focus, offering a potential solution to unlock significant financial savings.

It’s essential to understand how this model could reshape the sector and provide a lifeline to local authorities struggling to offset rising operating and delivery costs.

Historically, VAT treatment has varied depending on governance models – in-house models and private sector operators saw their income being subject to VAT, but they could also reclaim VAT on relevant expenditure. By contrast, not-for-profit trusts benefited from a level of VAT-exempt income but couldn’t recover VAT on expenditure, including on capital projects.

The March 2023 changes to the treatment of VAT altered this dynamic, making in-house models far more VAT-efficient. While this has prompted some councils to consider switching to in-sourcing, external management remains financially attractive, due to benefits such as pension cost mitigation and economies of scale on sales and marketing and the purchase of big ticket items such as gym equipment.

Against this backdrop, the agency model has emerged as a compelling alternative. The concept has been employed in local authorities for years for capital projects, whereby operators do capital works on behalf of councils – as their agent – so VAT is recoverable, reducing project costs.

What’s new is the application of this model to operational contracts, driven by the potential financial benefits unlocked by the 2023 changes to VAT.

Under this type of agreement operators act as the agent for councils, collecting their income and as this is non-business, VAT is then recoverable on expenditure.

Analysis by Max Associates found the irrecoverable VAT cost-per-leisure-centre under traditional agreements with not-for-profit organisations ranges from £70,000-150,000 annually, so scaling this across the sector could yield savings of £50-£80m per year – a transformational figure for a sector grappling with utility cost volatility, and rises in minimum wage and National Insurance contributions.

Early adopters, such as the London Borough of Hounslow’s LATCo and Hillingdon Council – the first council to employ an Agency Agreement Model (March 2024), have shown the feasibility of this approach. Larger operators are leading the charge, embedding agency agreements across multiple contracts. Our records show a number of councils have had leisure management agency agreements passed by Cabinet, with around 40 councils in the process of tabling the option.

Procurement practices are evolving to accommodate this shift, with councils testing the model’s viability during pre-procurement, incorporating it as a variant option or requiring operators to demonstrate its financial and contractual robustness.

Larger contracts are the first targets, due to their potential for substantial savings.

However, the challenge remains to disseminate the model to smaller councils and operators, where even modest savings could be the difference between a facility remaining financially viable or not.

As with any innovative approach, risks exist. These include the potential for HMRC to challenge the model and the administrative complexities of implementing agency agreements across diverse contracts.

Larger operators have invested significantly in advice to mitigate these risks and ensure compliance. However, smaller operators and councils may require additional support to navigate this landscape.

Collaboration between stakeholders, including operators, councils and advisory bodies, is crucial to realising the full potential of this model. Procurement practices must be transparent and informed by solid legal and VAT advice.

We recently hosted an online roundtable with PSTAX to explore the merits of an agency model while discussing the challenges and risks. The event attracted representatives of more than 80 councils, highlighting a significant appetite for information and exploration.

As councils and operators navigate this transition, we must prioritise this kind of knowledge-sharing and capacity-building to enable smaller operators and councils to participate in and benefit from this shift.

Meanwhile, sector bodies, such as Sport England, need to consider including information within their guidance documentation to reflect the opportunities and risks.

These agreements represent a rare opportunity to align financial efficiency with the sector’s ambition to reduce inactivity.