VAT Partial Exemption

As a general rule a taxpayer can only recover VAT on expenditure in relation to its taxable business activities. In this respect “taxable” means that VAT is charged at either the standard rate, the reduced rate or the zero-rate.

If a taxpayer makes exempt supplies (for example insurance commissions, interest, residential rents) or undertakes non-business activities (most common examples are charities undertaking activities where there is no charge to the recipients), then there is no general right to deduction of VAT incurred on expenditure.

In a perfect tax world, taxpayers would either undertake activities that are taxable or activities that are not taxable. In the real world, many taxpayers have a mixture of both taxable and non-taxable activities. It is at this stage that the spectre of “partial exemption” arises.

Strictly, partial exemption only applies when a taxpayer has taxable and exempt business activities, meaning that some expenditure is used for both types of activity. The VAT has to be apportioned between the activities using a “partial exemption method”. Where a taxpayer has business and non-business activities, an apportionment of VAT on expenditure is required between the activities, known as a “non-business attribution”. Some taxpayers (for example, Colleges of Further Education and many charities) are unlucky enough to have to perform both a non-business attribution and a partial exemption attribution.

The practical problems associated with partial exemption.

This is one of the least understood VAT issues, gives rise to many queries and assessments from HMRC, has led to a number of complex cases within the tribunals and courts and, as a bottom line, costs businesses money in terms of:

VAT that cannot be recovered (especially bad news if you had not provided for the cost);

Finding the information necessary to perform the calculations required (set up finance codes just for VAT?); and

Satisfying the needs of HMRC (and they can be very demanding).

The outcome of the attribution of input tax should be “fair and reasonable”. The big issue is that the term is subjective often leaving a gulf between what the taxpayer and HMRC believe to be fair and reasonable. In our experience, that gulf only works in one direction – we have never heard of an instance where HMRC believe that the taxpayer is entitled to reclaim more tax than the taxpayer expected to be the case!

How Covertax can help you.

We are experienced at addressing the issues arising from partial exemption and non-business attribution such as: –

Dealing with HMRC enquiries and challenges to businesses that have not previously been treated as partially exempt;

Agreeing non-business attribution methods;

Agreeing partial exemption methods;

Performing partial exemption annual adjustments;

Dealing with capital goods scheme adjustments (if you don’t know, you don’t want to know!);

Dealing with related anti-avoidance legislation (and there’s a lot of it);

Working with you to improve information systems;

Negotiating with HMRC; and

Taking forward your dispute with HMRC to the VAT Tribunal or elsewhere.

You will no doubt have observed from the above list that the task is both technically complex and may often involve difficult negotiations with HMRC. It also usually requires detailed financial analysis, often of closed accounting periods.