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HMRC internal manual

VAT Cost Sharing Exemption Manual

How the conditions are to be interpreted: Directly Necessary services: Can the 85% test be applied on a sector/account basis?

HMRC will, in certain circumstances, accept the 85 per cent test being applied to particular parts of a member’s business provided the test can be reasonably applied. For example if the member has a sectorised partial exemption and business/non-business method they can apply the test on a sector basis. If a particular sector qualifies, the member can receive all supplies from their CSG that are attributable to that sector on an exempt basis. The test could also be applied on the same basis if, for example, a member can identify specific account codes in its accounting system; if the test is satisfied on that basis a member can receive all supplies from their CSG that are directly attributable to that account code on an exempt basis.

In these circumstances the test would have to be applied to external supplies and not to supplies made and received within the same VAT entity as they are neither exempt nor non-business supplies for the purpose of the Cost Sharing Exemption.

The treatment of ‘directly necessary’ services is currently under review following the CJEU judgment in Commission v Luxembourg (case C-274/15).  When that Review has been completed, HMRC will announce any changes to take effect going forward.