Enter Your E-mail

VAT Voice by Andrew Needham

Even though a partly exempt business undertakes a partial exemption calculation each quarter, once a year it will have to do its ‘annual adjustment’ as well, explains Andrew Needham, Director of VAT Solutions (UK) Ltd

Throughout the year

When a business makes exempt supplies it will be doing a partial exemption calculation at the end of each VAT period. Some periods it may be within the de-minimis limits and, therefore, able to claim back all of its VAT and in others there may be some restriction in the amount of VAT that can be reclaimed. Once a year the business will also have to recalculate the figures to see if it has claimed back too much or too little VAT overall. This is known as the partial exemption annual adjustment. Legally, the quarterly/monthly partial exemption calculations are only provisional, and do not crystallise the final VAT liability. That is done by the ‘annual adjustment’.

The first stage in the process of recovering input tax is to directly attribute the costs associated with making taxable and exempt supplies as far as possible. The VAT associated with making taxable supplies can be recovered in the normal way while there is no automatic right of deduction for any VAT attributable to making exempt supplies.

The balance of the input tax cannot normally be directly attributed, and so will be the subject of the partial exemption calculation. This will include general overheads such as heating, lighting and telephone and also items such as building maintenance and refurbishments.

The calculation

Using the partial exemption standard method the calculation is based on the formula:

Total taxable supplies (excluding VAT) / Total taxable (excluding VAT) 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, 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.

However, remember that there are certain things that should not be included in the calculation (Regulation 101(3) SI 1995/2518). Sales of the following are excluded from the standard method partial exemption calculation:

• the sale of capital items (for example motor cars – obviously not for a car dealer - etc); and

• certain incidental supplies such as the sale of land or building or financial services such as the sale of shares etc.

The is no definition of ‘incidental’ but ‘on-off’ sales such as the sale of a factory by an otherwise fully taxable business, or certain regular income such as bank interest are considered to be incidental to the main business activities.

These items are not included in the calculation but the VAT is still directly attributed, so for example the VAT incurred on a share floatation (exempt supply) would not normally be recoverable while the VAT on the sale of a commercial property on which the option to tax had been exercised (taxable supply) could be recovered.

Once a year

Depending on a businesses VAT return quarters, its partial exemption year ends in either March, April, or May. The business has to recalculate the figures during the VAT period following the end of its partial exemption year and any adjustment goes on the return for that period. So, the adjustment will appear on the returns ending in either June, July, or August. If a business is newly registered for VAT its partial exemption “year” runs from when it is first registered to either March, April or May depending on its quarter ends.

Special methods

The majority of businesses use what is known as “the standard method” and the example below uses this method. This method has legal force and is contained in Regulation 101, SI 1995/2518. However, use of the standard method is not mandatory and a business can use a “special method” that suits business activities better. Any special method has to be “fair and reasonable” and it has to be agreed with HM Customs & Excise in advance (Regulation 102, SI 1995/2518). When using a special method no rounding of the percentage is permitted and it has to be applied to two decimal places.

Commonly used special methods include those based on staff numbers, floor space, purchases (the standard method uses sales) or transaction counts, but providing it is ‘fair and reasonable’ anything goes.

However, even if a business uses a special method it will still have to undertake an annual adjustment calculation once a year using its agreed special method.

De-minimis limits

If a business incurs exempt input tax within certain limits it can be treated as fully taxable and all of its VAT can be recovered. If it exceeds these limits none of its exempt input tax can be recovered. The limits are:

• £625 per month on average (£1,875 per quarter or £7,500 per annum); and

• 50% 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).

The partial exemption annual adjustments are not errors and so do not have to be disclosed under the voluntary disclosure procedure. They are just another entry for the VAT return to be made in the appropriate VAT period.

If a business fails to carry out its partial exemption annual adjustment it may be lousing out on some input VAT that it could have claimed, as in our example. Conversely, it may also show that it has overclaimed input tax. When an HM Customs & Excise inspector comes to visit he will check that a business has done the annual adjustment, if it hasn’t, and this has resulted in an over-claim of input VAT, he will assess for the error, charge interest, and if appropriate, a misdeclaration penalty equal to 15% of the error.

April 2005

Andrew Needham
Director, VAT Solutions (UK) Ltd
Email: andrewneedham@vatsolutions-uk.com

VAT Solutions (UK) Ltd
11 Winmarleigh Street,
Warrington,
WA1 1NB

(T) 01925 242497
(F) 01925 242498
(M) 07810 433927
(W) www.vatsolutions-uk.com

VAT Solutions (UK) Limited is an established independent firm of Chartered Tax Advisers, formed by Andrew Needham and Steve Allen. The company has a cross-section of clients from multi-national companies through to medium-sized and numerous smaller regional firms of accountants and solicitors. They produce a regular publication 'VAT Voice', which can be downloaded directly from the Internet via the following address: www.vatsolutions-uk.com/newsletter.doc