When a business is VAT registered and makes, or intends to make, taxable and exempt supplies and incurs input tax that relates to both kinds of supply, it is classed as ‘partially exempt’.
If your business is partially exempt, it means you can only recover the input tax attributable to taxable supplies. VAT you incur on purchases that are used exclusively for non-business purposes is not input tax and you cannot recover it.
So, how do you know how much input tax you can recover?
Partial exemption can be problematic as it is not always easy to identify the VAT liability of supplies and then correctly apportion these supplies to taxable and exempt input tax. Here we take a look at some of the steps to take in calculating how much input tax you can recover and the key partial exemption rules to be aware of.
Calculating how much input tax can be recovered
There are three main steps when it comes to calculating how much input tax your business can recover:
1. Allocate your costs between:
- “directly attributable to taxable supplies” (identifying VAT incurred on purchases that you use, or intend to use, exclusively in making taxable supplies or other supplies that carry the right to deduct); and
- “directly attributable to exempt supplies” (purchases that you use, or intend to use, exclusively in making exempt supplies or other supplies in respect of which input tax is non-recoverable).
2. Apportion the residual input tax:
- There will be some expenses that do not relate directly to either taxable or exempt supplies, such as business overheads – these need to be apportioned; and
- There are special anomalies to be aware of here, such as the Capital Goods Scheme and Reverse Charge rules.
3. Complete an annual adjustment:
- The input tax claimed over the year is only provisional, and at the end of your VAT year you recalculate the residual input tax and the amount that you can recover; and
- This will take into account any differences in the percentage of recoverable residual input tax that may occur between tax periods in the same longer period.
Apportioning residual input tax
HMRC set out a ‘standard method’ of apportioning the residual VAT – to put it simply, this uses a calculation to determine how much of your residual input tax is attributable to taxable supplies and therefore recoverable.
The standard method is typically used by most small businesses and, for the majority, will result in a ‘fair and reasonable’ recovery of input tax.
If the standard method does not bring about a recovery of input tax that is ‘fair and reasonable’, then a ‘special method’ may be used.
A special method will be specific to your business and is developed to deal with unique circumstances. It must still contain the essential elements of an apportionment calculation:
- Reflecting all your business activities;
- Providing for direct attribution of input tax to taxable supplies;
- Providing for direct attribution of input tax to exempt supplies;
- Identifying residual input tax;
- Calculating the element of residual input tax that relates to taxable supplies;
- Calculating the element of residual input tax that relates to exempt supplies; and
- Allowing you to determine the total input tax that you can recover.
You must not use a special method, or change a special method that you are already using, without the written approval of HM Revenue & Customs.
The de minimis rule
Where your exempt input tax is insignificant, you can treat it as if it were taxable input tax and recover it in full, if its total value is less than a prescribed amount.
An amount that is insignificant is known as ‘de minimis’.
This rule applies where the total value of exempt input tax is not more than:
- £625 per month on average; and
- Half of your total input tax (excluding any blocked input tax, such as the costs of business entertainment) in the relevant period.
Every time you prepare the figures for your VAT Return you must check if your exempt input tax exceeds the de minimis limit. When applying the de minimis limit you should ignore any input tax due to you or from you as adjustments under the Capital Goods Scheme, or under your annual adjustment.
How M+A Partners can help
Partial exemption can be a complex area for VAT-registered businesses. The rules on recovering input tax are not always straightforward and there are many variables to take into consideration.
M+A Partners’ specialist tax team provides expert advice to partially exempt businesses, ensuring input tax is apportioned and recovered accurately. For further guidance on this topic, please get in touch with me using the details below or email enquiries@mapartners.co.uk