Partial VAT Exemption

What is this about?

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 the perfect tax world (which does not exist), 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.

So why's this an issue - VAT's supposed to be a simple tax after all?

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 a taxpayer money in terms of:

1. VAT that cannot be recovered (especially bad news if you had not provided for the cost);
2. Finding the information necessary to perform the calculations required (set up finance codes just for VAT?); and
3. 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 has never arisen because HMRC believe that the taxpayer is entitled to reclaim more tax than the taxpayer expected to be the case.

OK, so it is a problem. How can Covertax help?

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

• Dealing with HMRC enquiries of taxpayers who may not currently be attributing input tax;
• 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.

This sounds costly

There's no hiding it, it is - because the work is time consuming whether using your own staff, or external advisers.

Work related to attribution of input tax tends to: -

• Require detailed analysis work, often of closed accounting periods
• Involve protracted discussions, negotiations or disputes with HMRC
• End up with an answer you don't like - you can claim back less tax than you expected.

There are exceptions to these rules, and we feel that we provide a cost effective service to a budget, with reasonable expectations of the outcome set at the outset, and occasionally delivering a result that exceeds those expectations.

What now?

If you've got this far you: -

• Have got an issue
• Have worked out that we know what we're talking about
• Are not put off by the fact that it's a painful and costly process.

For more information please contact us.