A tax loophole is allowing NHS trusts to avoid paying VAT on outpatient medicines by contracting out pharmacy services to private chemists, depriving the Treasury of a lucrative income stream worth millions.
The loophole has been exposed by investigative website Exaro, which found that HMRC allows chemists to reclaim VAT paid on a wide range of medicine, but does not extend the same courtesy to NHS pharmacies located in hospitals.
As the taxman views the dispensing of drugs as part of hospital's 'non-business activities' it is therefore subject to non VAT-recoverable status.
But independent chemists located inside hospitals can reclaim the VAT charged on medicines bought for hospital outpatients.
The loophole has led to scores of partnerships between trusts and independent pharmacies and high street companies such as Boots, Lloyds Pharmacy and Sainsbury's Healthcare who sought to take advantage of the VAT rules.
Between them the pharmacies have over 30 hospital outpatient operations with a variety of trusts throughout the UK, such as Guy's and St Thomas' NHS Foundation Trust in London, South Tees Hospitals NHS Foundation in the North East and the Bradford Teaching Hospitals NHS Foundation Trust.
The loophole is entirely legal and was even subject to an HMRC clarification of its rules in November 2012.
An HMRC spokesman said: 'HMRC is aware that some Trusts have been entering into structures that seek to bring third party pharmacy services onto hospital premises. HMRC is currently reviewing the different structures being used.'
'NHS Trusts who are looking to improve their patient experience may well find they are able to make financial savings through the current VAT regulations if they provide services via a thrid party.
'Patient experience should be the driving factor in deciding to make service changes not the opportunity to make financial savings,'said Calum Polwart, network pharmacist, North of England Cancer Network and pharmacy clinical team manager at the County Durham & Darlington NHS Foundation Trust.
An e-petition calling for the Treasury to zero-rate VAT on all medicines was launched in 2011, and closed in August 2012, but only managed to garner 22 signatories. 100,000 signatures are needed to trigger a possible debate in the House of Commons.
Stanley Dencher, CCH VAT specialist, said: 'Due to the significant amounts involved, HMRC will examine the contractual arrangements for providing medicine to outpatients and the claims to recover VAT charged on purchasing the medicine, especially in view of the duty of the hospital to treat patients.
'There is probably no half-way house, between exemption and zero-rating. If necessary, the law will be changed to stop any arrangements that, in the eyes of the politicians, avoid VAT in an unintended way.'
Currently all medicines purchased over the counter are subject to 20% VAT, while FP-10 prescriptions - those issued by GPs, nurses and pharmacists - are exempt from VAT, as are private prescriptions. NHS hospitals also have to pay VAT on all their medicines.