What could the proposed changes mean for VAT and Employment Taxes? 

Local government reform has become one of the defining themes of public sector change across the UK. 

While much of the attention to date has focused on Local Government Reorganisation in England, the Scottish Government has now set out initial proposals for significant changes to local governance in Scotland. 

Published on 21 September 2026, the opening proposition would replace the current local government arrangements with 6 to 10 regional authorities, focused on strategic decision-making, alongside 120 to 160 community authorities focused on more local decision-making. Bespoke arrangements are also proposed for Scotland’s island communities. 

These are not final structures. The Scottish Government has described them as a starting point for discussion, with further engagement planned with local government, Parliament, communities and other stakeholders. 

If reform on this scale proceed, however, it would represent a major restructuring of Scottish local government and could have significant implications for VAT, Employment Taxes and wider tax governance. 

Structural reform creates tax consequences regardless of the final model 

Much of the debate will understandably focus on governance, accountability, community representation and how services should be delivered. 

For council finance and tax teams, there is another important question: 

What services, assets, contracts, employees and funding arrangements could move under a new structure? 

The tax implications will depend on the final model and how responsibilities are divided between regional, community and national bodies. 

There is currently uncertainty around areas including: 

• the final number and geography of regional authorities; 
• the responsibilities of regional and community authorities; 
• which functions could move from existing public bodies; 
• future education governance; 
• social care arrangements; 
• transport, housing and economic development responsibilities; and 
• how national, regional and local functions will interact. 

The Scottish Government’s proposal specifically raises the possibility of changes across housing, planning, employability strategic plan, transport, education, social care and other services, although the allocation of functions and responsibilities remains open for discussion. 

Each could create different VAT and Employment Tax considerations. 

VAT preparation can begin before structures are finalised 

Experience of structural change elsewhere in the public sector shows that waiting for every detail to be decided can leave a significant amount of work to complete close to implementation. 

There are areas Scottish authorities can review well before final boundaries or structures are known. 

These include: 

• historic VAT recovery positions; 
• options to tax; 
• Capital Goods Scheme records; 
• Partial Exemption methodologies and available headroom; 
• Business/Non-Business methodologies; 
• shared service arrangements; 
• grants and funding streams; 
• fees and charges; 
• property and asset ownership; and 
• existing contractual structures. 

This work can provide value regardless of the final outcome of the reform discussions. 

Good records will also become particularly important if assets, services or responsibilities eventually move between organisations. 

Questions around who owns an asset, who incurs expenditure, who receives funding, whose name appears on an invoice and who is making or receiving a supply can all affect the VAT treatment. 

New regional and community arrangements could create new VAT relationships 

A new structure would not necessarily mean services simply transferring from one existing council to another organisation. 

The Scottish Government’s proposition envisages regional and community decision-making operating alongside one another, supported by regional administrative structures. It also raises the possibility of functions currently sitting elsewhere in the public sector moving into regional or local democratic structures. 

That could create new funding, contracting and shared service relationships. 

Authorities may therefore need to consider: 

• whether payments represent grant funding or consideration for a supply; 
• how shared services are structured; 
• who contracts with suppliers; 
• which body incurs and recovers VAT; 
• how property and other assets are transferred or shared; 
• whether existing options to tax are affected; and 
• any Partial Exemption or Capital Goods Scheme consequences. 

These questions are much easier to address while arrangements are being developed than once contracts, funding agreements and operational structures are already in place. 

Employment Taxes will be a significant part of reform planning 

The workforce implications could be just as substantial. 

Any restructuring of local government raises questions about who employs people, how they are paid and which organisation takes responsibility for existing Employment Tax obligations. 

Authorities should have a clear understanding of their current workforce and arrangements, including: 

• employees and employing entities; 
• PAYE schemes and payroll arrangements; 
• apprenticeship levy considerations; 
• employment status; 
• off-payroll workers; 
• agency workers; 
• contractors; 
• CIS compliance; 
• expenses and benefits; 
• existing policies and processes; and 
• Employment Tax risks or historic issues. 

This is also about retaining knowledge, so when organisations, teams and systems change, important information can easily become fragmented. Understanding current arrangements before responsibilities move can help ensure that records, decisions and compliance knowledge transfer with them. 

Reform can also provide an opportunity to review whether existing processes remain appropriate before they are carried into a new organisation. 

Social care, education and other services will need particular attention 

The Scottish Government has made clear that the allocation of functions is still open for discussion. 

Its proposals specifically identify social care as an area requiring further consideration, alongside potential changes affecting education, housing, transport, economic development and other public services. For tax teams, these interfaces matter. 

A service moving between organisations can change: 

• who employs the workforce; 
• who enters into contracts; 
• how services are funded; 
• which organisation owns or occupies property; 
• how expenditure is incurred; and 
• which VAT recovery rules apply. 

The organisational chart alone will therefore not provide the tax answer. 

What can Scottish councils do now? 

There is still a long way to go before the final shape of Scottish local government reform is known. That does not prevent authorities from preparing. 

A useful starting point is to ask: 

What do we currently deliver, who delivers it, who pays for it, who employs the people, who owns the assets and where are the existing tax risks? 

Building that picture now creates a much stronger starting point if responsibilities are subsequently transferred, combined or redesigned. 

It can also identify existing VAT recovery opportunities or Employment Tax issues that are worth addressing regardless of structural reform. 

Lessons from reform elsewhere 

One recurring lesson from Local Government Reorganisation, devolution and wider public sector reform is that tax rarely sits neatly within one programme workstream. 

As new structures are developed, decisions around governance, funding, property and the workforce can all affect the tax position. VAT recovery, Partial Exemption, property treatment, PAYE, employment status, off-payroll working and CIS may all need to be considered as responsibilities and services move between organisations. 

Tax therefore needs to connect with finance, HR, payroll, property, procurement, legal and programme teams throughout the reform process. 

Bringing tax specialists into those discussions early gives authorities more opportunity to identify issues while arrangements can still be shaped. 

Frequently asked questions about Scottish local government reform and tax 

Will Scotland replace its 32 councils? 

No final decision has been made. The Scottish Government’s initial proposition is to replace the existing arrangements with 6 to 10 regional authorities and 120 to 160 community authorities, with separate arrangements potentially applying to island communities. The proposals are intended to inform further discussion and consultation. 

What are the VAT implications of Scottish local government reform? 

The VAT implications will depend on what functions, funding, assets and contracts move and how new organisations are structured. Areas to consider could include VAT registration, Partial Exemption, Business/Non-Business treatment, property, the Capital Goods Scheme, options to tax, grants, shared services and contractual arrangements. 

Should councils start tax preparation before the final structure is known? 

There is work that can be undertaken without knowing the final boundaries or structures. Reviewing current VAT positions, records, methodologies, contracts, assets, workforce arrangements and existing risks can provide useful information for reform planning and benefit the authority’s current position. 

What Employment Tax issues could arise from local government reform? 

Potential areas include PAYE schemes, payroll transfers, employment status, off-payroll working, contractors, CIS, expenses and benefits and the transfer of existing policies, records and compliance knowledge. 

Speak to our Scottish local government tax specialists 

PSTAX already works closely with Scottish local authorities on VAT and Employment Tax matters. 

Ashley Little, VAT specialist, supports public sector organisations with the VAT issues that can arise from structural and operational change, including VAT recovery, Partial Exemption, Business/Non-Business treatment, property, assets, funding and contractual arrangements. 

Christine Robinson, Employment Taxes specialist, advises public sector employers on areas including PAYE, employment status, off-payroll working, CIS, expenses and benefits and the workforce implications of organisational change. 

As discussions around Scottish local government reform develop, Ashley, Christine and the wider PSTAX team can help authorities understand what can be reviewed now, which tax issues may arise under future structures and where early action could reduce risk or identify opportunities. 

If your authority is beginning to consider the implications of reform, speak to Ashley or Christine to discuss your current VAT and Employment Tax position and the practical preparation that can begin now.