What local authorities, police, fire and NHS bodies should do now

Public sector reform is no longer a future issue. It is happening now, and for many organisations, the tax consequences will arrive long before the new structures go live.

In our latest monthly Breakfast Briefing, we focused on two points that are easy to miss as the current reform programmes accelerate:

1. Reforms to one part of the public sector will have consequences for other parts
2. One of these consequences is tax

Tax does not sit neatly in one workstream. VAT, partial exemption, land and property, shared services, PAYE, CIS, salary sacrifice, and governance all cut across the wider programme. That means local authorities, police bodies, fire and rescue services, NHS organisations and other public bodies need to start early, not wait for final structural decisions.

That matters because several major reforms are now moving at the same time. The government’s local government reorganisation programme began with the English Devolution White Paper in December 2024. Ministers then invited councils in 21 areas to develop proposals, and Surrey is now on track for implementation from 1 April 2027. Alongside that, the government announced in March 2025 that NHS England will be brought back into the Department of Health and Social Care, and the government is reviewing the current NHS VAT refund scheme. On top of all that, the government published a policing white paper proposing major structural change, including the abolition of PCCs in 2028, and transferred ministerial responsibility for all fire functions to MHCLG from 1 April 2025.

All these changes will have tax consequences that public bodies should prepare for now.

Why tax needs attention early

Tax problems don’t begin on vesting day; they usually begin earlier, when historic issues are carried forward into a new structure, when contracts and coding are not reviewed, or when payroll and VAT arrangements are overhauled without enough lead time.

It is vital for tax to know what issues the new unitaries could inherit and what public bodies can do now to minimise risk and additional costs.

For some organisations, that will mean unresolved VAT issues. For others, it will be PAYE scheme changes, CIS verification, options to tax, partial exemption methods, or the practical question of who is responsible for existing agreements and compliance activity. The earlier these issues are identified, the easier they are to deal with while choices are still open.

Local government reorganisation is only part of the story

Local government reorganisation is getting most of the attention, and understandably so. Government policy is to end the remaining two-tier system and create new single-tier unitary councils. By March 2025, all 21 invited areas had submitted interim plans, and Surrey’s structural changes order now provides for two new councils from 1 April 2027.

But LGR is one strand of a much wider reform programme. If your organisation works closely with NHS bodies, police, fire, subsidiary or arm’s length companies, pooled budgets or shared service arrangements, you can be affected even when your own structure isn’t changing.

That matters because most current tax arrangements were designed around the current structure of public bodies; once that changes, the tax position often changes with it.

What NHS reform could mean for VAT and joint working

In March 2025, the government announced that NHS England will be brought back into the Department of Health and Social Care, with work beginning immediately to return many of NHS England’s functions into the department.

However, more importantly for VAT is the likely change to the NHS VAT refund mechanism (section 41 of the 1994 VAT Act). The Treasury has been reviewing the scheme for a couple of years (or more) and it is likely to change to a wider-ranging refund arrangement, which will have knock-on effects for other public bodies.

Pooled budgets, partnership arrangements, shared teams, co-location, and joint working agreements are everywhere in the public sector. And most were set up around NHS VAT structures that might not exist for much longer. Agreements between local authorities and NHS bodies are the obvious example, along with joint working between the blue light services (such as co-location). But anywhere costs, recharges, and VAT recovery is based on the current section 41model needs review.

Even small changes in legal form, governance, or operational control can affect who bears the VAT costs, how recharges are treated, and whether the arrangement still works as intended. For public bodies already under budget pressure, that is not something to leave until late in the process.

LGR VAT issues public bodies should be reviewing now

From a VAT perspective, LGR is not one issue but a long list of connected issues that need to be reviewed in a structured way. Even apparently simple matters such as VAT registration and de-registration cannot be assumed to proceed without specialist review and intervention.

One of the most important issues is VAT reporting and HMRC interaction. How are VAT returns prepared today? What controls and governance sit around them? Are there live HMRC enquiries or disclosures? How would any of that carry into a new authority?

Another is wider compliance. If VAT treatments are inconsistent across services now, those inconsistencies do not disappear when authorities merge. They get harder to sort out. Fees and charges are a good example. If the VAT treatment is wrong or inconsistent across predecessor bodies, the risk passes to the new authority.

Capital projects and partial exemption need particular attention. Major projects that begin before vesting and continue afterwards need careful planning. Authorities should know how those projects affect VAT recovery, whether the capital goods scheme could come into play, and whether different partial exemption positions across the merging authorities will cause issues when they’re combined.

Land and property matters also need early attention. Authorities should understand the VAT treatment of their property transactions and, in particular, the current position of their options to tax. In some statutory transfer situations, options to tax fall away, creating a rare chance to review whether they still need to be in place for the new body. That can be a real planning opportunity, but only if the position is identified early enough.

Other specialist areas matter too. Issues can be created during reorganisation from cultural exemption, PFI arrangements, shared services, delegated functions, employee benefit schemes, and finance system coding involving subsidiary or trading companies.

Police reform could create another layer of tax change

The policing white paper published in January 2026 sets out a programme of structural change. It proposes a new National Police Service, says the current system is based around 43 local police forces, and states that Police and Crime Commissioners would be abolished in 2028, with governance moving to Strategic Authority Mayors or Policing and Crime Boards. The government also says it wants fewer, larger police forces over time.

For tax purposes, that raises practical questions straight away.

Existing Police VAT registrations and VAT groups may need to be reviewed. Asset ownership might move. Agreements with HMRC may need to be revisited. If statutory transfer rules apply, some VAT consequences could be different from a standard transfer, but that depends on the legal framework used. To name just a few things, options to tax, capital goods scheme treatment, and the handling of emergency vehicle arrangements will all need review.

However, an additional and important point for all public bodies to keep in mind is that police reform is not just a policing issue. It can have knock-on effects for local authorities, ambulance trusts, fire services and others working through shared arrangements or joint estates.

Fire reform should not be treated as separate from the rest

From 1 April 2025, ministerial responsibility for all fire functions moved from the Home Office to MHCLG.

That does not mean every fire body faces immediate structural change. But it does underline the wider point from this briefing: several reform programmes are happening at once. For organisations with linked services, estates, shared buildings, joint teams or joint governance, tax planning needs to reflect the whole picture rather than one reform in isolation.

Employment tax risks are just as important

VAT tends to get attention first in reform work. Employment taxes can cause just as much disruption if they’re not thought through.

Where a new legal employer is being created, new PAYE arrangements will usually be needed. HMRC registration, payroll software, pay frequencies, data migration and the handling of large numbers of starters and leavers all need to be thought through in advance. If they are not, organisations can quickly run into tax code errors, payroll failures and reporting problems.

Expenses and benefits need review too. Different predecessor bodies may operate different policies. Once structures change, questions arise around permanent and temporary workplaces, home to work travel, relocation support, temporary accommodation, benefits in kind and salary sacrifice. Reform can force policy harmonisation, but the tax consequences still need to be worked through.

IR35 and employment status also need close attention. Reform periods often bring in more consultants, interims and programme staff. New bodies cannot assume old determinations will still stand. Each legal entity needs its own process, clear records and a workable approach before engagements begin.

Then there is CIS. Public bodies meeting the deemed contractor rules must have the right registrations, references, and verification processes in place. Where a new legal entity is created, re-verification may be needed. If that work is left too late, contractor payments can be delayed, which will create operational problems as well as a tax problems.

What public bodies should do now

PSTAX was the sole tax advisor for the last four rounds of LGR. That means we can draw on that unique experience to recommend the best approach to LGR at this stage.  Even if your final structure is not yet settled, or as soon as it is, we recommend a practical tax review.

That review should cover:

• current VAT reporting and compliance controls
• live HMRC enquiries, disclosures and known historic issues
• fees and charges treatment
• partial exemption methods and calculations
• capital projects and capital goods scheme exposure
• land, property and options to tax
• shared services, recharges and delegated functions
• payroll set-up, PAYE schemes and benefits
• IR35 processes and off-payroll engagements
• CIS registrations, references and subcontractor verification
• group structures, trading companies and VAT groups

You do not need every answer immediately. But you do need a clear view of the risks, the dependencies and the issues that will take time to fix.

The main message from this reform period

The tax position should not be left to the end of the programme.

By the time a new authority, board, or structure goes live, the tax work should already be done. That means understanding the current position, identifying what the new unitaries will inherit, deciding what should not transfer, and dealing with the practical details well before vesting day or legal change.

For public bodies, the risk is not only getting the technical answer wrong but carrying old problems into a new structure, creating avoidable VAT cost, payroll disruption, compliance gaps, and operational delays at exactly the point the organisation needs a smooth transition.

Public sector reform is already moving. Tax work needs to move with it.

Contact the team

Public Sector Reform FAQs

What is the main tax risk in local government reorganisation?

The biggest risk is not one single tax rule. It is carrying unresolved VAT, PAYE, CIS and governance issues into a new authority and having to fix them after go-live, often accompanied by a large HMRC penalty or time costly assessment.

Does LGR only affect councils?

No. LGR is council-focused, but the tax effects can spread wider where there are shared services, pooled budgets, and arrangements with third parties.

Why should options to tax be reviewed during reform?

Because statutory transfers can change the position. In some cases, this may create an opportunity to reconsider whether options to tax still need to be kept in place. However, to be able to reconsider option to tax, the new unitaries need to know their projected partial exemption position for their first year after vesting, and for as far into the future as possible.

Why does employment tax need early planning?

Because payroll, PAYE registration, benefits, IR35 and CIS are operational as well as technical. If they are not ready in time, the consequences can affect staff and suppliers immediately.

What is the best first step?

Start with a tax mapping exercise of the current position. That gives the programme team a clear view of risks, timing and where expert input is needed first.

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