Apportionment of tax: methods for apportionment of tax
The simplest method of apportionment is for the business to adopt a fixed percentage figure. It then applies this to the total non-attributable VAT it incurs.
This can be an acceptable approach in cases where:
- the balance of the activities of the business does not fluctuate; and
- there is a good reason for adopting a particular percentage.
It can also be effective for those who:
- normally only undertake business activities; but
- undertake a one off non-business project involving a specific item of expenditure.
An example of this would be where a company hires an entertainer to provide a free Christmas party to the children of its employees and those from a local school.
Other indicators of non-business activity
The level of business and non-business activities may move up and down. When this happens a business should adopt a method of apportionment which can take account of any changes.
An ongoing apportionment method should reflect changes in the balance of activities. Therefore a method of business/non-business apportionment must be based upon reliable indicators of activity. There are many such indicators and methods based upon them.
Income based methods
Income is an obvious indicator of non-business activity. Income based methods are the most common business/non-business apportionments.
They usually work by the business:
- calling the income it gets from business supplies ‘business income’; and
- calling the income it gets from outside the scope sources such as grants ‘non-business’ income.
The apportionment is calculated each quarter by taking dividing the business income by the total income:
|Total income from business supplies (business income)||= 2000|
|Total income from grants (non-business income)||= 3000|
|Total income from all sources||= 5000|
|Apportionment (2000/5000)||= 40%|
- are simple;
- rely on accounting information that is usually easy to get;
- rely on accounting information that can be easily checked; and
- are easy to work out the result from.
Sometimes they may not give a fair and reasonable result. This will be the case if the balance of activity does not reflect the balance of funding.
For example, an organisation that spends most of its time and resources on non-business activities may still get the majority of its income from business supplies. If this is so an income method would give a result that does not reflect the real non-business purpose behind most of the mixed expenditure.
An income based method will not give a fair and reasonable result if the commercial activities of a business are partly subsidised by grant income. For example, a basic income method would give a misleading result if applied to a heavily subsided transport operator who also ran free community projects.
Sometimes you can adapt income methods so that distortive income is taken out of the calculation. Alternatively you can weight the calculation in some way.
Complex income methods can work well when income is the best indicator on which to base a method. However, sometimes they can lead to a calculation that is over complicated to operate and monitor. When this happens it is usually better to find another, simpler method based on a different indicator.
Although an income based method is given as an example in section 33.5 of The VAT Guide, HMRC does not have an automatic preference for such methods. They are acceptable only if they give a fair and reasonable result and are simple to operate.
Expenditure based methods
These are a mirror of the income based method. In this type of method the business applies the ratio of business/non-business expenditure to the non-attributable tax.
They are only appropriate if the business can:
- attribute most of its expenditure into distinct business and non-business categories; and
- this ratio is a fair reflection of business and non-business activities.
When there is little directly attributable expenditure these methods give a misleading result and should not be used. An example of this would be where most of the tax incurred is non-attributable. When this happens there is unlikely to be sufficient information for the apportionment to be reliable.
Expenditure based methods are also not appropriate if the ratio of attributable expenditure is likely to be different from the extent of business use of the non-attributable goods and services.
For example, a charity with mostly non-business expenditure may buy a computer system to make taxable supplies of publications. It might only use the computer incidentally for non-business activities. When this happens, an expenditure based method could lead to an apportionment that understates the business purpose behind the computer purchase.
Time based methods
Some organisations keep detailed records of the amount of time spent by staff on business and non-business activities. This can provide a useful basis for a method of apportionment if the business/non-business ratio of staff time reflects the extent of business use of non-attributable costs.
In some cases staffing policy does not give a true indication of what VAT bearing goods and services will be used for. This is especially true if:
- the organisation’s non-business work is staff intensive; and
- its business activities are goods and services intensive.
For example, an organisation may spend 90% of its staff time making free supplies of verbal advice to members of the public. The remaining staff time is spent making taxable supplies of publications and on paid consultancy services.
Unlike the non-business work this business activity involves the charity spending money on goods and services rather than the non-VAT bearing wages of its staff. A simple time based method would lead to an apportionment that understated the true balance of business use of the overhead goods and services.
Transaction based methods
Some methods based upon a record of transactions such as:
- paid admissions to a museum; or
- books loaned out for a charge by a library
may be proposed.
A common difficulty with such methods is that non-business activities often do not involve recordable transactions. In contrast the business activities will involve making charges and making distinct, recordable supplies. In such cases a transactions based method can lead to an unfair result.
HMRC staff will not automatically dismiss transaction based methods. However, we will want to be sure that they are founded on a valid indicator of business and non-business activity.