VAT - Partial Exemption Can Include Land And Property
It's a given that VAT and partial exemption are complicated areas of tax. More importantly, many people don't realise the potential that exists for them to pay less VAT than first glance might suggest. Partial exemption doesn't always mean 'non recoverable'.
There are key rules that impact on calculating what can and cannot be recovered depending upon your individual business circumstances and this blog is an introduction to the topic. For example, the VAT associated with a flat above your business premises that you rent out might not be fully exempt. We've used this example as a case study at the end of this blog but first we need to get technical and look at definitions:
This is how the government introduces the topic:
"Some goods and services are exempt from VAT. If all of the goods and services you sell are exempt, your business is exempt and you won’t be able to register for VAT. This means you can’t reclaim any VAT on your business purchases or expenses. If you are VAT-registered and incur VAT on any items that will be used to make exempt supplies, you are classed as partly exempt."
Exempt goods and services
Be clear on exactly what is defined as 'exempt goods and services' - they include finance, health, education and land but you'd be advised to access the exact list. If you have any non-business activities (such as renting out a flat above your shop) that incur VAT these too are regarded as exempt. But good news lies in the 'de-minimis' rules...
De-minimis is a threshold applied to the VAT on your unrecoverable (eg exempt) supplies. If you are below the limit then all VAT incurred in that quarter can be reclaimed in full. There are 2 conditions you must meet to be below the de-minimis limits. Basically, if the input VAT attributable to exempt supplies is less than £625 per month (on average) and less than 50% of all input tax, it can be reclaimed in full.
Exempt, Taxable and Residual VAT categories
Before you can calculate your quarterly bill accurately, you must apportion your input VAT into 3 categories: Exempt (as defined above, including the de-minimis rules), Taxable and Residual. The latter is the VAT that doesn't fall into either category - eg overheads, accountancy fees. As a partially exempt business, you'll need to use an approved method to calculate how much of your residual input tax can be recovered. The standard calculation is on basis of use - using the split between taxable and exempt turnover in the business.
You can apply to HMRC to use a special method for the calculation, eg transaction-based or staff numbers. For tax years commencing on or after 1 April 2009 it is possible to base the initial residual input VAT recovery on the previous year’s recovery percentage. This recovery figure is then finalised, as usual, through the annual adjustment (our next item).
The Annual Adjustment
In addition to completing your VAT returns on a monthly or quarterly basis, you should also calculate your exemption (including the de-minimis limit) for each period. Then, at the end of the VAT year (either the March, April or May quarter end) you must make an annual calculation to identify whether the de-minimis limit has been breached in the yearly figures (either the final return of the year or on the first return of the following year). This will ensure you remain as tax efficient and compliant as possible.
Be prepared for a positive, negative or neutral effect on the VAT recovery:
- If your annual calculation confirms that the de-minimis threshold has not been breached then all the input VAT you incurred in the year can be recovered, including the input VAT attributable to exempt supplies. So, if in any of the monthly or quarterly periods the de-minimis threshold was breached and input VAT recovery was restricted then, this input VAT becomes recoverable by means of the annual adjustment.
- If your annual adjustment reveals that the de-minimis limit has been breached, this could have the adverse effect that input VAT attributable to exempt supplies recovered in an individual period would then become repayable to HMRC.
A VAT Partial Exemption Case Study
Here's the example we introduced earlier: a stock-based business (such as retail) with a flat above a shop, rented out through the business. The figures reflect the whole of the business - not just the flat rental:
Net (£) VAT (£)
VATable supplies 135,000 12,500
Exempt supplies 55,000 7,000
Residual (eg accountancy fee) 2,000 400
Now work out the allowable (VAT) amount allowable on the residual based on the standard calculation of usage:
£135,000 x 100
£135,000 + £55,000 = 71%. Apply this to the residual: £400 x 71% = £284
Then, the annual adjustment de minimus rule is applied:
Input VAT directly attributable to exempt supplies: £7,000
Exempt proportion of the residual input VAT: £116
Total input VAT on exemption: £7,116
Total input VAT on all supplies excluding capital purchases: £19,900
£7,116 = £593 per month (on average)
So: £7,116 x 100 = 35.75%
This example meets the criteria of the de-minimis rule and means that the whole VAT amount of £7,116.00 is recoverable, thereby making you better off by £7,116.00.
If, like a lot of people, you've assumed that VAT exemption means just that - exempt - you may be pleasantly surprised. At the very least, due diligence on your part will keep your business tax compliant. Our outline above barely breaks the surface of the level of detail that might be relevant to your business. The government website https://www.gov.uk/government/publications/vat-notice-706-partial-exempt... is reasonably informative but it's no substitute for tax advice that's pertinent to your business. At Rajani & Co, we've got tax experts experienced in all types of business so we're on hand if you need our support and guidance.