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VAT Partial exemption

For businesses making both taxable and exempt supplies
 
General rules
For a business that only makes sales that are subject to VAT at either the standard, lower or zero rate, all of the input tax that is incurred on its expenditure can be reclaimed.

For businesses that only make exempt supplies, VAT cannot be reclaimed. Such businesses are ineligible for VAT registration entirely.
Complications arise where a business has a mixture of sales, some of which are vatable and some of which are exempt.

There are rules that are intended to make sure that only the VAT relating to taxable activities is reclaimed, but to prevent the situation where every single transaction has to be analysed, a broad set of principles has been established that businesses can use to calculate their VAT liabilities.

Where the VAT attributable to exempt supplies is minimal, a de minimis limit has been established, and where input tax is below that limit, it can be reclaimed in full without any restriction.

The basic rule is that if the input tax attributable to exempt supplies is less than £625 per month on average, and is less than 50% of all input tax suffered, it can be reclaimed in full.

Simplified tests
To make things even simpler for smaller businesses, there are two simplified tests that can be used each quarter when preparing VAT returns:

  1. If the total amount of input tax is less than £625 per month on average, and exempt supplies are less than 50% of total supplies, input VAT can be recovered in full
  2. If the total input tax less the input tax directly attributable to taxable supplies is less than £625 per month on average and exempt supplies are less than 50% of total supplies, input VAT can be recovered in full
These tests must be performed each quarter.

A further simplification that is available is the VAT recovery rate established by the previous years annual adjustment throughout the following year without having to do any quarterly calculations at all.

Annual adjustment
At the end of each year, no matter how the figures on each quarter's returns have been calculated, an adjustment has to be made to ensure that the figures put together on a quarterly basis do not need to be amended. This might be the case where, for example, there are two quarters where full input reclaim has been possible and two where it hasn’t. The overall position is calculated with an adjustment being made as appropriate. This might lead to more VAT becoming payable but equally might result in VAT being repayable.
Full reclaim of all input tax suffered will be allowed if the total input VAT relating to exempt supplies during the year is less than £7,500 (12 times £625) and is less than 50% of total input tax.

Depending on the VAT return stagger that a business has, the annual adjustment will be calculated at the end of either quarter ended 31 March, 30 April or 31 May, and any adjustment necessary has to be made on the next VAT return due (i.e. the one ending on 30 June for a business with a 31 March VAT period end). However a business can choose to account for the adjustment in the earlier period if it wishes to.
 
To conclude, consider all the activities of the business, including those that are secondary and incidental and identify any exempt supplies.  If exempt supplies are identified, ensure that a partial exemption calculation is carried out.
For further information on any of the elements raised within this article contact us today.

Andrea Wulff 01243 531600
[email protected]

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