VAT - 21.12.2006

Using your own partial exemption method

Partial exemption problem

Authorisation change. The rumour seems to have been based on changes announced in the 2006 Budget concerning the authorisation process for partial exemption special methods. So what exactly is this?

Recap. Input VAT cannot normally be recovered on the costs associated with making an exempt supply. If you make a mixture of exempt supplies and taxable supplies you are partially exempt.

De-minimis. If your exempt input tax is below certain limits (known as de-minimis limits) you recover it all anyway. Currently these limits are that the exempt input tax is less than: £625 per month on average (£1,875 per quarter or £7,500 per annum); and50% of the total input VAT (the VAT on purchases relating to taxable supplies should always be greater than the VAT on exempt supplies to pass this test). If you exceed either of these limits you will not be able to recover your exempt input VAT. This is where using a “special method” comes in.

Step 1. The first stage in the process of recovering input VAT is to directly attribute the costs associated with making taxable and exempt supplies. Any purchases directly attributed to making taxable supplies can be recovered in full.

Step 2. The balance of the input VAT (light, heat and other general overheads) cannot normally be directly attributed, and so will be the subject of the partial exemption calculation. Most businesses use what is known as the partial exemption standard method. The calculation is based on the formula: (Total taxable supplies/total taxable and exempt supplies)x 100 = %. This gives the percentage of non-attributable input VAT that can be recovered. The figure calculated is always rounded up to the nearest whole percentage point, so, for example, 49.1% becomes 50%. This percentage is then applied to the non-attributable input VAT to give the actual amount that can be recovered. Problem. The standard method does not always give a fair and reasonable result so when that is the case a business is allowed to negotiate a special method with the VATman.

Special solution

Fair and reasonable. In theory, you can have any special method you like providing it gives a fair and reasonable result. Before you use a special method you must have it agreed with the VATman first. Common special methods use staff numbers, floor area, transaction count or purchases, but others can be used if appropriate.

The change

New declaration. From April 1, 2007 the method of authorising special methods will change. Businesses will need to declare that “to the best of my knowledge and belief” the proposed partial exemption special method was fair and reasonable. Problem. An overzealous VATman could cause havoc revoking previously agreed special methods and issuing large assessments as a result.

Tip. If a visiting officer considers that an agreed special method is not fair and reasonable he has to refer it headquarters for them to decide if it should be revoked. However, disputing an existing special method is unlikely.