Value-added tax costs FE millions every year. Most of it goes to Customs and Excise who pass it on to the Treasury, and - if colleges are lucky - it might even find its way back into FE.

A typical college with a total income in the region of pound;10 million faces an annual bill of up to pound;500,000. Large fluctuations will normally occur if a college carries out extensive building work.

In addition, colleges pay an average of pound;1,000 per year to tax advisers to help them reduce their tax bills by reclaiming money from Customs and Excise according to the amount of non-educational business activity taking place in a college, and by devising VAT-saving schemes.

Calculating where colleges can reclaim tax and where they cannot is very complicated. As providers of goods and services in shops and restaurants, for example, colleges must also charge VAT (although not to students).

The annual cost of administering such a system can easily come to another pound;1,000. According to the College Finance Directors Group, it is ridiculous that so much money is spent on administration and paying outside experts to advise colleges how to save money. “This is public money which is leaking out of the system,” says Peter Lennard, the group’s chairman.

VAT was never an issue when colleges were under local authority control. Councils could claim back any VAT they incurred in the same way as they still do for schools. Since 1993, the Further Education Funding Council has supposedly included a sum to cover VAT in the grant it pays to colleges, which are classed as charities.

But as building costs and information technology bills have risen, as the areas where colleges must charge and - in theory - recover VAT have been extended, more and more managers claim that they are worse off than in 1993. “VAT has become a cost to colleges in a way that itwasn’t at incorporation,” says Mr Lennard, director of finance at Soundwell College, Bristol.

Most college activities are exempt from VAT because they are directly related to education or training. Yet colleges still pay the tax on any goods they buy specifically for teaching and other educational purposes, including research.

Although students cannot be charged VAT on course fees, for example, Mr Lennard believes Customs and Excise officers have been set targets to raise more in tax from “partially-exempt bodies” such as FE colleges by focusing on goods and services that do attract VAT.

During the past two years,for example, colleges have been instructed to charge VAT on canteen meals sold to lecturers and other staff, as well as members of the public, although not to students. Colleges complain that some local tax offices enforce this more strictly than others.

Such inconsistency, combined with increasing pressure to raise VAT from other sales, has heightened tension between finance directors and the taxmen. “Customs and Excise have toughened their stance towards FE colleges,” says Peter Wintersgill, a VAT manager with the financial consultants Arthur Anderson. He believes FE is suffering because of the collapse of a concordat between universities and Customs in 1997. “Colleges have been hit by the fall-out. Customs and Excise have hit back and both sectors and being tarnished with the same brush.”

Mr Wintersgill stresses that inconsistencies in the advice given out by VAT officials in different parts of the country are nothing new. Firms in most industries would probably make the same complaint. “The difference is that you only have 450 colleges and they talk to one another and so the inconsistencies come out.”

He believes the best option would be to classify FE colleges as Section 33 bodies, which would allow them to reclaim VAT in the same way as councils. “Although a lot of college funds don’t come from the public sector, it’s ridiculous they have these costs.”

Two years ago, following a government review of charity taxation, colleges hoped the issue would be ironed out. The finance directors group argued that either colleges should be able to reclaim VAT as local authorities do or that education should be zero-rated. This would be another way of making it easier for colleges to recover more of the tax paid out to suppliers. Although students would still not pay VAT on anything other than items that already attract the charge, colleges could recover VAT they paid out in buying materials that led to education being delivered by teachers.

Neither option has been accepted by the Government although a new VAT helpline is promised for all taxpayers in 2001. According to Customs, an extension of zero-rated VAT to cover education would contravene European Union law while neither colleges or universities meet the criteria for being classed as Section 33 bodies.

A spokeswoman for Customs and Excise denies VAT offices are inconsistent in enforcingpartial-exemption. “There is not really any room for local discretion,” she said. “The position is quite clear. Colleges are partially exempt under UK and EU law. If they increase business activity they can reduce the amount of exemption.”