15. Partial exemption
Actions to take if a business is registered for VAT and incurs input tax relating to exempt supplies.
If a business is registered for VAT and incurs input tax relating to exempt supplies, that business is partly exempt. This means that it may not be able to claim all the input tax it incurs and that it will normally have to use a partial exemption method to work out how much input tax can be claimed.
You can find more information about partial exemption and methods of calculation in Partial exemption (Notice 706).
Partial exemption requirements apply to all VAT traders including those which are insolvent or in receivership or administration.
As office holder you must comply with these requirements in respect of any returns you complete for pre or post relevant VAT periods.
An insolvent business may seek approval from its local VAT office for a change of method to calculate its entitlement to input tax recovery, given the change in circumstances.
We will apply its normal policy, as set out in section 6.11 of Partial exemption (Notice 706), to when any new method can apply from with the exception that the method cannot be applied to any pre-insolvency returns.
When a business is already partly exempt it may seek approval from us to end its current tax year at the relevant date and to make its annual adjustment in the VAT period ending with the relevant date. Such applications should be clearly marked ‘VAT partial exemption query’ and sent to the VAT Written Enquiries Team:
BT VAT
HM Revenue and Customs
BX9 1WR
United Kingdom
If we do not allow approval for a change, the annual adjustment is to be made in accordance with the normal rules set out in Partial exemption (Notice 706).
If the insolvent business had assets covered by the Capital Goods Scheme (read Capital Goods Scheme (Notice 706/2)) then those assets pass to the office holder on insolvency. If the use of the assets changes whilst under the office holder’s control then adjustments may arise, which must be declared on returns due from the office holder.
The office holder will need to establish this information:
- what assets covered by the CGS are held
- when they came into use in the business
- how much input tax was initially incurred and deducted on them
15.3.1 Asset still used within the business
Any adjustments are likely to be modest as they will only address the time of use by the office holder and the difference between their use and that originally made by the business prior to insolvency.
If the office holder brings the company out of insolvency or sells its assets as a transfer of a business as a going concern then any CGS items will pass on to the new owners at that point.
15.3.2 Assets no longer used within the business but held for eventual sale
If the original use was taxable and the sale will be exempt then there may be substantial adjustments due. As the sale will be made by and under the direction of the office holder adjustments must be declared by them on returns that they submit.
If the asset is a building then it may be possible to prevent the sale from being exempt by opting to tax (read Opting to tax land and buildings (Notice 742A)), although this may restrict what buyers may be interested.
If the original use of the assets was partly exempt, and if the sale is to be taxable, then adjustments in the office holder’s favour may arise.
If the business cancels their VAT registration without a sale of the asset taking place then an adjustment may arise at that time.
15.4.1 Insolvent business formerly fully taxable or treated as fully taxable continuing to trade
When a business remains fully taxable or continues to be treated as fully taxable, the input tax on the office holder’s fees, and all other overheads, will be recoverable.
When the business carries on trading and becomes partly exempt, it will have to apply a partial exemption method in the normal way. Recovery of input tax, including that on the office holder’s fees, could be subject to restriction in accordance with the partial exemption method used.
15.4.2 Insolvent business formerly partly exempt continuing to trade
When the business remains partly exempt, recovery of input tax, including that on the office holder’s fees, could be subject to restriction in accordance with the partial exemption method in place in the normal way.
You should request a change of method from your local VAT office if, due to changing circumstances, the method in place no longer produces a fair and reasonable attribution of input tax to taxable supplies.
15.4.3 Insolvent business which was fully taxable, or formerly treated as fully taxable, ceases to trade but remains registered pending sale of assets
When the business has ceased to trade, the principal activity will be the sale of assets.
If the assets which are sold are exempt, the business may become partly exempt. Any input tax relating to the sale of the exempt assets would then need to be restricted according to a method. But the office holder’s fees should be treated as an overhead to the business prior to insolvency and, since that was fully taxable, they’re fully recoverable subject to the separation of any third party costs.
15.4.4 Insolvent business, which was partly exempt, ceases to trade, but remains registered pending sales of assets
When the business has ceased to trade, the principal activity will be the sale of assets.
Recovery of input tax is subject to restriction in accordance with the partial exemption method which is in place in the normal way. But the office holder’s fees should be treated as an overhead of the business prior to insolvency and, since that was partly exempt, they will be subject to restriction.
The business should continue to use the method in place in the normal way.
A change of method should be requested from the local VAT office if, in the light of changing circumstances, the method in place no longer produces a fair and reasonable attribution of input tax to taxable supplies.
15.4.5 Insolvent business that have cancelled their VAT registration
VAT is only recoverable on services which, although supplied after the registration was cancelled, relate to former taxable supplies made by the business.