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HMRC internal manual

Business Income Manual

From
HM Revenue & Customs
Updated
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Value Added Tax: partial exemption

The broad principles set out in BIM31525 to BIM31535 should be relatively simple to apply:

  1. where the turnover is wholly exempted (or because turnover is below the registration threshold) the trader is not required to and has not opted to register),

or

  1. where the turnover is wholly taxable (whether at the standard or reduced rate or at the zero rate).

The trader, however, may be a taxable person whose turnover is partly exempt. Partial exemption is common particularly in the financial field.

The VAT rules are as below:

  • If the trader is registered for VAT and they incur input tax that relates to exempt supplies, they are partly exempt.
  • If the amount of input tax incurred which relates wholly or partly to exempt supplies (the ‘exempt input tax’) is below certain de minimis limits, input tax can be claimed as if the person was fully taxable.
  • In all other cases where the trader is partly exempt, the input tax cannot be claimed in full.

Input tax on goods and services use for making both taxable and exempt supplies and on general business overheads can be claimed only to the extent attributable to taxable supplies, calculated by making an apportionment on an agreed basis. HMRC have made regulations which provide a standard method for determining claimable input tax and which also enable them to agree alternative special methods in those cases where the standard method does not provide a fair and reasonable result. Further information on partial exemption methods can be found in VAT Notice 706 `Partial Exemption’.

The basis on which input tax is to be apportioned between taxable and exempt supplies is a matter for agreement between HMRC and the individual trader. For the purpose of calculating trade profits the relevant expenditure is inclusive of any input tax which is not claimable. It follows that if the input tax that is not claimable relates to, for example, capital expenditure, it is not deductible as an expense in calculating the profits but it may rank for capital allowances.

Trade profits treatment

Partial exemption may involve an apparently artificial division between the trader’s receipts and expenses as regards his taxable turnover and those as regards his exempt turnover. There may therefore appear to be practical difficulties in implementation as regards the calculation of trade profits. An apparent, additional complication is that for a partly exempt trader, the input tax claimed in each VAT period is provisional. These provisional claims are adjusted when the trader carries out an annual adjustment at the end of his VAT year (normally ending on 31 March, 30 April or 31 May) depending on the periods in which they make their VAT returns.

Generally, in the case of partly exempt traders, provided the treatment is reasonably in accordance with the broad principles set out above and in BIM31525 to BIM31535 the overall apportionment agreed by HMRC for VAT purposes is acceptable for trade profits purposes. In particular, relatively small amounts of unrelieved VAT on capital expenditure charged against profits may be disregarded. Any unusual difficulties met in dealing with partial exemption in computing trade profits should be referred to CTIS (Technical).