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Have the doors been blown open for the Managed Service Contract? HMRC versus Glos Hospitals


The Managed Service Contract is not universally accepted in NHS Finance circles. For those not familiar, a Managed Service Contract (MSC) is the supply of a defined service by a commercial supplier to Government Departments (including the NHS). In certain circumstances, VAT can be recovered on the contracted out service under a Contracted-Out Services Direction (COSD). The purpose of COSD is to allow commercial organisations and in-house teams to compete on a level playing field i.e. unencumbered by VAT, which, other things being equal, means a commercial company would always be 20% (the VAT rate) more expensive than the in-house team (where VAT is not applicable). The HMRC-specified services are allowed under Section 41(3) of the Valued Added Tax Act 1994, which enabled the application of the COSD , an administrative regime that defines the services that fall within the scope of the VAT recovery mechanism.  

Section 41(3) therefore, arguably, creates a competitive market to drive improvement. As such, the competition to provide COS defined services offers opportunities to reduce costs, access private capital, know-how and transfer risk, benefiting the tax payer. In the NHS setting, the use of MSCs has become commonplace in pathology, imaging and endoscopy, providing much needed capital refreshes and cost savings. 

For the NHS Finance naysayers, the MSC has been misunderstood, viewed as a tax loop-hole, waiting to be exposed and closed! In fairness, HM Treasury has published its own assessment here. BUT… on 30th January 2023 a legal judgement provided reinforcement for the validity of the MSC, supporting full VAT recovery. The case explored, in depth, the service and legal form of an Agreement for the Management and Administration of Surgical Facilities under contracted out services heading 45 (COS45) and its treatment for VAT recovery purposes. The ruling found in favour of full VAT recovery.  

The Theatre Services MSC was contracted by Gloucester Hospitals NHS Foundation Trust. HMRC had refused the recovery of VAT on the consumables element of the contract, where consumables represented around 70% of the total contract value. In the eyes of HMRC the consumables were considered a separate supply i.e. not part of the “single supply” of healthcare facility services. The judgement in HMRC versus Gloucester Hospitals NHS Foundation Trust at the Upper Tribunal (Tax and Chancery Chamber) on 30 January 2023 disagreed with HMRC. 

The Tribunal tested the MSC on four grounds to reach its decision:

Ground 1: the Trust is entitled to a refund of VAT in respect of the consumables on the basis that the supply falls within Heading 45 to the COS Direction (the operation of healthcare facilities and provision of related services). 

Ground 2: The title of consumables does not pass from the supplier to the Trust under the Agreement i.e. there is no supply of goods (the ‘Title Issue’). Instead, the supply of the Consumables is an element of a single supply of managed theatre services under the operation of healthcare facilities (the ‘Single Supply Issue’). 

Ground 3: The supply of the consumables is a supply of goods closely related to the supply of managed theatre services. 

Ground 4: HMRC have adopted differential and inconsistent treatment for contracted out theatre services such that its treatment of the Trust is unfair, irrational and an abuse of power (this related to another NHS

Trust that was receiving full VAT recovery for an equivalent MSC at the inception of the Gloucester Hospitals contract).

The judgement was successful for Gloucester Hospitals i.e. that VAT was fully recoverable on Ground 2; the judgement extract summarised in:

“…we are satisfied on an objective basis and from the point of view of the typical consumer, namely an NHS Trust, that the supply of the services and consumables are so closely linked that they form a single, indivisible economic supply which it would be artificial to split. We would describe that single composite supply as the supply of a fully managed theatre facility and we are satisfied that it falls within paragraph 2(a) of COSD and COSD 45 either as the operation of a healthcare facility or as services related to the operation of healthcare facilities by the Trust itself.”

In respect of the other Grounds: Ground 1 was dismissed since the concept of ‘supply’ is linked to the VAT Act and so attention turned to Ground 2 as to whether this was a composite supply. Given the conclusion in Ground 2 was that the supply did constitute a composite supply Ground 3 was effectively left undecided and unnecessary i.e. “…whatever construction of [COS45] paragraph 2(c) is adopted, the supply of Consumables under the Agreement is closely related to the supply of services and would qualify for a refund under paragraph 2(c).” Ground 4 was dismissed in favour of HMRC, in that they were judged to have acted perfectly reasonably, with no inequity or unfairness intended in reaching their conclusion with regard to their decision.

The outcome of this case creates a real precedent for the validity of the MSC and an NHS Trust’s ability to reclaim VAT on the whole supply. The fact that consumables represent the significant proportion of the supply, that the title of the supply was judged to have passed to the Trust did not influence the judgment that VAT was indeed recoverable on the composite of the service making up the supply of a healthcare facility, in this case a Theatre/Surgical Facility.  We would conclude that this opens the door to a wider range of NHS facilities that can be appropriately constituted as a “single supply”.

The full decision is available: Glos Hospitals vs HMRC


  1. The services broadly covered maintenance, facilities management, sterilisation, procurement (supplier management, product negotiation and recalls), catalogue and stock management, IT services, data analytics, management, consumables and other services to enable the surgical facility to be ready and available for use.
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