VAT partial exemption
A business that incurs expenditure on taxable and exempt business activities is termed as partially exempt for VAT purposes. In essence, the business has to make an apportionment between the exempt and chargeable activities using a ‘partial exemption method’. This is required in order to calculate how much input tax is recoverable.
There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could distort the numbers. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual allocation of inputs. It is possible to agree a special method with HMRC.
Under certain conditions, the VAT incurred on exempt supplies can be recovered. This is subject, however, to two, parallel de-minimis limits. The tests are met, and VAT can be recovered on exempt supplies, where the total value of exempt input tax:
- Is under £625 a month (£1,875 a quarter/£7,500 a year); and
- Is less than half of the total input tax incurred.
If both tests are met the VAT can be recovered. Businesses that are partially exempt, need to complete this calculation on a quarterly and annual basis. Please call if you need help making these calculations.
HMRC have confirmed their policy on the VAT partial exemption ‘payback’ rules following a recent High Court decision. This concerned the Community Housing Association (CHA) which won their appeal. HMRC have confirmed that they will not be appealing the decision.
The VAT regulations (109) where the payback rules are contained allow businesses to ‘recover’ input tax on costs which were incurred to make exempt or partly taxable supplies but are then instead used to make taxable or partly taxable supplies. A payback claim cannot be made unless the following three conditions are met:
- the expenditure in question relates to items or supplies that were not used as originally intended
- the change of use arises after the end of the partial exemption longer period (if there is one)
- the change of use results in taxable supplies or both taxable and exempt supplies if the original intention had been to make a wholly exempt supply
In the CHA case, a structure was put in place involving a subsidiary company between CHA and its suppliers. The High Court ultimately ruled that input tax was deductible using the ‘payback rules’ as there were supplies between CHA and its subsidiary.
HMRC have included some final comments in their new business brief as to what constitutes the basic requirements for a supply. HMRC state that the “the recipient of the supply must receive some benefit, he must provide some consideration and the consideration must be paid in return for the benefit…… The mere raising of invoices and passing of funds between companies does not automatically create supplies. Careful analysis may be called for, especially if the companies are close associates.”