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Government bodies’ use of the three channels (procurement, grant, grant-in-aid) available for funding the activities of TSOs has been highly inconsistent in relation to TSOs. There are a number of reasons for this:

  • Many actual cases do not fit neatly into any one of the three channels
  • Until recently, there has been little good guidance to funders and commissioners on the appropriate circumstances in which to use a particular channel
  • In recent years, for good policy reasons, governments have extended the concept of grant to include grant with conditions about levels of service and grants awarded following competition between potential recipients. This has blurred the distinction between grant and procurement.

In addition, funders and commissioners use terminology loosely, in two ways:

  • Following procurement, the government body and the provider reach a financial agreement known in law as a ‘contract’. Because of this, the procurement channel is widely referred to as ‘contract funding’. Following the award of a grant, the government body will send the provider a ‘grant letter’, ‘award letter’ (or a similarly-named document. For grant-in-aid, a formal financial memorandum will set out the terms and conditions. However, the courts may well decide that a grant or grant-in-aid is a contract, if it has the legal substance of a contract, whatever it is called
  • The term ‘service level agreement’ (SLA) is sometimes used to describe an agreement between funder and recipient. SLA is not a term with any specific status. Both contracts and grant letters may contain agreements on service levels to be delivered by the recipient [Footnote 1].

Funders and commissioners sometimes do not know which channel they are using or believe that they are using one channel when they are in fact using another.

EU law has had a major impact on UK procurement law, and the knock-on impacts on other channels are still being fully worked through. The Treaty of Rome covers all public sector procurement contracts within the European Union and sets down principles of non-discrimination, equal treatment and transparency. The new EU procurement Directives 2004/18/EC and 2004/17/EC, which were implemented in UK law on the 31 January 2006, support the Treaty principles with detailed provisions relating to specifications, selection and award of contracts above certain thresholds.

The situation continues to develop: for example, the NAO’s recent report on government’s financial relationships with TSOs suggested that, as more TSOs established strategic partnerships with government, grant-in-aid might become more widespread for funding TSOs [Footnote 2].

In principle, the distinction between financial channels is technical: all the money in question is public funding. However, there are practical consequences. In particular:

  • When you choose the procurement channel, your decisions are governed by a large and detailed body of EU and UK law. Guidance from the Office of Government Commerce (OGC) explains both this and the government’s Value for Money policy [Footnote 3]
  • Grant and grant-in-aid can allow more flexibility and discretion to the funder to vary the required outputs;
  • The choice of channel affects what recipients are able to do with any surpluses (i.e. whether or not the funder will seek to‘claw back’ surpluses) [Footnote 4]
  • The VAT position may differ: sometimes the amount of irrecoverable VAT incurred by the TSO may be less under the procurement channel. You should seek advice on your position from HM Revenue and Customs.

There is no hard-and-fast rule as to which funding channel is appropriate for a particular situation. However, some factors tend to make procurement more suitable while others favour grant or grant-in-aid. Procurement is often favoured where:

  • Funding is being provided primarily for specific service or project objectives, rather than for ‘development’ or ‘strategic’purposes
  • The market of potential suppliers is well-developed – there are several potential suppliers to choose from, who have the capability to meet your objectives, can respond easily to new demands and where there is little risk of market failure during the period of your programme. A well-developed market should also mean that price benchmarks for the service will be available.

Conversely, grant or grant-in-aid is often more suitable where development or strategic funding is emphasised. Other factors which tend to favour grant or grant-in-aid are:

  • A desire for innovative or experimental products or services
  • Outcomes (the desired end results) rather than outputs (the measurable or numerical results of a given input) are to be specified.

Grant-in-aid is particularly favoured where the funding situation is ‘non-contestable’, i.e. where there is a unique supplier.


  1. In this DST, an SLA is either:
    • An agreement on service levels within either a grant-in-aid letter, a grant letter or a contract.
    • A ‘quasi-contract’ between two organisations that have the same legal personality (for example, two government departments) and so cannot enter into an actual contract with each other.
  2. NAO, Working with the Third Sector, TSO, 2005.
  4. This is covered in Stage 3: Determine payment formula.

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Annex E: Examples of funding models