For years, the question of whether local authorities should charge VAT on leisure services has been a point of contention with HMRC.

HMRC’s longstanding view was straightforward: leisure centres and sports facilities were business activities, so income was subject to VAT. Local authorities disagreed, arguing that they were providing leisure under statutory duties, not as commercial ventures.

The issue ended up in the courts, starting with cases like Midlothian Council v HMRC (2015) and Mid Ulster District Council v HMRC (2017). In both instances, judges sided with the local authorities, ruling that these services were delivered in fulfilment of public functions and could not be classed as economic activity. The most significant ruling to date was Chelmsford City Council v HMRC (2019), where the Upper Tribunal confirmed that in-house leisure services should be treated as non-business.

HMRC finally accepted this position in March 2023, updating its policy to confirm that when local authorities run leisure services themselves, the income is outside the scope of VAT.

The change offers a specific financial benefit for in-house leisure delivery models, allowing them to fully recover VAT on their costs without having to charge VAT to customers for the majority of services. But the ruling has also opened the door to a new approach.

The agency model offers a solution for optimal VAT efficiency whilst benefitting from economies of scale which support reduced revenue costs of delivering leisure and active wellbeing services.

Emerging evidence shows the agency model could deliver an improved average annual financial position of c. £100,000 per site.

Advocates see it as a way to unlock VAT savings and improve value for money. Sceptics warn it is still relatively untested, more complex than is often portrayed and potentially presents local authorities with additional burdens and risks.

What is the agency model?

Under the agency model, the authority is the “principal” providing leisure services to the public, while the operator acts as the “agent” delivering those services on behalf of the authority.

This structure means:

  • The authority treats income as non-business for VAT purposes.
  • The authority recovers VAT on associated costs, including the operator’s service fee.
  • The operator avoids irrecoverable VAT, reclaiming VAT on its own costs.

This creates clear financial advantages compared to traditional contracts given that the irrecoverable VAT costs incurred by operators can amount to hundreds of thousands of pounds for an individual contract. This cost is built into the management fee and effectively passed through to the authority.

The agency model is not unique to leisure services. Similar principal-agent arrangements are already established in other parts of the public sector. For example, in adult social care, local authorities often act as the principal commissioning care services, while independent providers deliver care on their behalf.

Likewise, in school catering, local authorities frequently retain responsibility for setting policy and pricing, while catering companies operate as agents managing day-to-day delivery of services.

These examples show that the agency model is a familiar concept in public service delivery, even if its application to leisure and wellbeing services is relatively new.

The standard vs. the operator-proposed model

Under a typical agency arrangement, the local authority, as principal, would retain a significant degree of commercial risk. In practice, this would mean the authority has no certainty over the net cost of its leisure services during the contract term.

Operators, however, are now putting forward a hybrid version. They propose retaining a fixed management fee, but adjusting the service fee charged to the authority to reflect the gap between the forecast net position (set out in their bid) and the actual net position achieved.

This approach removes the authority’s exposure to trading risk whilst still providing it with the VAT-related benefits. It also allows operators to bid more competitively, as the savings they make on irrecoverable VAT can be reflected in an improved management fee.

Opportunities and risks

With local authorities facing ever-tightening budgets, any additional savings can have a real impact.

The agency model could deliver substantial VAT-related savings that might be reinvested into improving and maintaining leisure and active wellbeing assets, subsidising more impactful targeted interventions and/or supporting other essential community services.

The benefits are clear: reduced VAT costs, improved contract value, and the ability for operators to pass on savings.

But these advantages come with real risks that need careful consideration:

  • Direct financial risk – if HMRC rules against the legitimacy of the specific agency agreement, or if a subsequent ruling or clarification prohibits this form of agency arrangement, unwinding it would create significant cost pressures. If the authority retains the risk of this happening, this could create a significant, unexpected budget gap.
  • Contract and service risk – if HMRC determines that a specific contract does not meet the required six agency tests, the risk might sit with the operator if they have structured the contract. In this case, the contract could become unviable, leading to a reduction in services or cost-cutting that undermines service quality.
  • Reputational risk – even if technically valid, authorities could face criticism if the arrangement is perceived to be a form of tax avoidance.
  • Additional resource risks – the proper application of an agency arrangement demands more of the authority than a traditional leisure operating contract. The authority, as “principal”, will need to ensure it has enough 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. To ensure the arrangement is more than a “paper exercise” there will also need to be real changes on the ground, for example in marketing, branding, customer correspondence and VAT-invoicing. If not properly considered at the outset, management of an agency arrangement may create unforeseen administrative burdens, placing extra demands on staff and resources.
  • Contract design and procurement risk – there is currently no standard contract for the agency model, so bidders typically propose their own approach to adapting the industry standard Leisure Operating Contract. This template is several years old and is still to be updated by Sport England. This creates additional work for the authority, including the need for legal review. It also increases the risk of sub-optimal contracts, as decisions often need to be made within a limited timeframe, using contracts that are adapted rather than designed specifically for this type of arrangement.

So how should agency-curious local authorities proceed?

Authorities considering this model should ensure they have a clear understanding of the risks and implications before they proceed. If this is being considered as part of a procurement process, sufficient time will need to be built in to avoid decisions being rushed and based on incomplete information. Some of the steps authorities should take include:

  • Take specialist VAT and legal advice – the model remains unchallenged as yet and HMRC has yet to issue any formal guidance (and perhaps won’t). Expert input will therefore be needed to ensure the arrangement fully meets HMRC’s specific requirements for agency models.
  • Engage with the market and other authorities – the preliminary market engagement process provides an opportunity to explore the specifics of agency models being applied by operators. Speaking to authorities that have already implemented this model may also provide learning from their experience and improve understanding of the practicalities and resources involved in implementing and administering an agency contract.
  • Be clear in procurement strategies – changing approach mid-process risks legal challenge. Whilst the new procurement regulations provide flexibility in testing different options, you’ll need to set these out clearly in the tender documents.
  • Understand the VAT position of all income streams – authorities should review which income can legitimately be treated as non-business. Some activities, such as secondary spend (e.g., café or retail income) or certain facilities like soft play, will generally remain standard-rated for VAT purpose.
  • Plan for unwinding – decide in advance where risks and liabilities lie if HMRC rejects the model. Be explicit on this in the tender documents as well as the contract itself.

How are local authorities putting an agency model in place?

Implementation of the agency model is emerging in two distinct ways, each with its own considerations and risks:

  • As a variation to an existing contract

Some local authorities are varying their existing leisure contracts to incorporate an agency arrangement. This approach can deliver VAT savings without going through a full procurement process, but it comes with specific risks:

    • Contractual complexity – existing agreements were not originally designed for principal-agent structures, so variations must be carefully drafted to meet HMRC’s six agency tests.
    • Legal and procurement risk – significant changes to contract terms could be challenged if they are deemed to materially alter the original procurement.
    • Operational alignment – local authorities need to ensure that practical changes (e.g., income flows, branding, invoicing) are implemented to demonstrate a genuine agency arrangement.
  • As part of a new contract arrangement 

Other local authorities are introducing the agency model through new procurements, often as a variant bid alongside a traditional management contract. This route allows:

    • Greater clarity and control – the contract can be designed from the outset to reflect agency principles.
    • Competition – including the agency model as a variant option during a procurement means the authority secures the optimal benefit (as opposed to sharing the benefit which is more likely under a variation to an existing contract). It also enables local authorities to compare financial benefits against traditional models.
    • Reduced legal risk – setting out the parameters and approach to testing the agency model through a new procurement avoids the potential challenge associated with retrofitting an existing contract.

Early adopters

The London Borough of Hillingdon became the first authority to adopt the model with a procured operator in March 2024. The London Borough of Hounslow has followed suit with its Local Authority Trading Company.

Beyond these examples, we know that a number of authorities have varied existing contracts to incorporate an agency approach or are procuring new arrangements on this basis, often seeking to test it through a variant bid. Some authorities are choosing not to implement an agency model but making provision for the contract to be amended in the future if/when it becomes more commonplace or HMRC issues guidance on it or adopts a clearer position. Thus there is cautious, but growing interest in the agency model.

The Bottom Line

The agency model could reshape leisure and active wellbeing commissioning in the coming years in a similar way that the leisure trust model did in the 1990’s / 2000’s. It offers clear financial benefits to local authorities under constant pressure to deliver savings. But it is complex and carries real financial, contractual and reputational risks.

Authorities should see it as an innovation worth exploring, but only with clear advice, a robust procurement process and a careful approach to risk allocation. It is not a “one size fits all”.

Further support

SLC is supporting authorities across the UK to assess the agency model and ensure clients are clear on the risks and opportunities, to enable them to make informed decisions. If you would like to discuss what this could mean for your authority, our team of experts are here to help.

Email info@slc.uk.com or call 01444 459927.