What Is VAT Partial Exemption? | Rayner Essex

What is VAT Partial Exemption?

Input tax is the VAT incurred on purchases/expenditure. It is worth remembering that the right to reclaim input tax is always only on the basis that the input tax has been incurred by the business and for a taxable business purpose.

What that means is that to reclaim input tax, the purchase must be directly related to the making of taxable supplies (standard, reduced or zero rated). A business that only makes taxable sales is known as a “fully taxable” business and can reclaim all the input tax it incurs in relation to its business activities.

An exempt business is one where it is not charging VAT because the supply is specifically exempt, such as healthcare, welfare, college/university education, etc). These businesses cannot reclaim any input tax because they only make exempt supplies.

Where a business makes both taxable and exempt sales, it is known as a “partially exempt business” and describes a business that incurs input tax on its purchases but that some of that input tax is not reclaimable, reflecting that the business itself is not “fully taxable.

The Stages of Partial Exemption Calculation

So partial exemption is very much about input tax and how much of it can be reclaimed by the business. The approach to this is via a partial exemption calculation, which sets out to apportion the input tax and the standard method uses sales as the main basis of the calculation.

Stage 1

Stage 1 involves analysing  the turnover and identifying the value of taxable (standard, reduced and zero rated) sales against exempt sales. Exempt sales are not to be confused with “outside the scope of VAT” (OTS) sales.  

For example, a business owns residential and commercial property and has a turnover of £100,000 p/r quarter, of which £70,000 is taxable (commercial) and £30,000 is exempt (residential), so the partial exemption turnover is split 70%/30%.

Stage 2

Next, analyse the purchases/input tax, referred to as “direct attribution”, think of this as 3 in-trays on a desk, one tray is for purchases used wholly only for making taxable supplies, one in-tray for purchases wholly for exempt use and the third in-tray is for those purchases which are not wholly used for taxable or exempt purposes, referred to as “residual input tax”.

For example, if the roof of the residential property needs a repair, the input tax is clearly related to the dwelling and the dwelling income is exempt so the input tax is assigned as “exempt input tax”. Whereas, work on a car park at a commercial unit is linked to the taxable rent charged for this unit and is assigned as “taxable input tax”. Finally, invoices for book-keeping and the office photocopier cannot be wholly taxable or exempt, so is treated as residual input tax.

We now have the three in-trays filled with purchase invoices and correctly reflecting the use to which these purchases have been put.

Stage 3

The final stage is the calculation, which in very simple terms means the business can reclaim all of the input tax in the “taxable input tax” in-tray and can also reclaim 70% of the input tax in the “residual” in-tray. The remaining 30% of that residual input tax and the input tax in the in-tray marked “exempt input tax” are added together.

There is then a further calculation, referred to as a “de minimis test”, which looks to see if the value of all the exempt input tax (the 30% residual plus the VAT identified as being exempt use only) is less than £1,875 per quarter (or £7,500 per year) and less than 50% of all input tax incurred in the year, the business is deemed to be de minimis and the 30% exempt input tax and the input tax in the “exempt input tax “ tray can be reclaimed in full.  Beyond that threshold, none of the 30% VAT or the exempt in-tray can be reclaimed.

Key considerations for VAT partial exemption calculation 

Partial exemption calculation ideally should be done each VAT quarter/period and there is also an annual calculation which must be performed in March, April or May (depending on your VAT return periods) which may see an adjustment to previously reclaimed input tax, the annual calculation reflects the whole year picture rather than the quarterly snapshot.

The above is a very simplified version of what goes into a partial exemption calculation, this article being designed to give a flavour of what is required, rather than being a step-by-step guide. If you are new to partial exemption then you should seek professional advice to ensure you are using an optimised approach, if you already have a partial exemption calculation, then you should ensure that it is reviewed to ensure that it continues to reflect the activities of the business and remains efficient in reclaiming the correct amount of input tax. 

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