VAT Input Tax basics: how to determine business use
Purposes of the business
Input tax incurred on a cost can be claimed if it relates directly to the function and carrying on of the business. If it merely provides an incidental benefit to the business it is unlikely that input tax can be claimed. Rosner (FW) (t/a London School of International Business) highlights this important distinction. See VIT61360.
This case establishes an important principle that the business needs to show a clear link between the expenditure and the actual sales carried out by the business. If this link does not exist then VAT cannot be recovered.
The High Court pointed out in its judgement:
“One only has to state that proposition [that expenditure incurred to defend the owner/manager of a business against criminal proceedings was for the benefit of the business] to appreciate that there can be no question of describing sensibly the legal expenses of a person who has been charged with an offence wholly unrelated to his business as being expenses incurred for the purposes of the business. Benefit, therefore, cannot be the test.
There must be a real connection, a nexus, between the expenditure and the business. It seems to me that the nexus, if it is not to be benefit, must be directly referable to the purpose of the business. By the purpose of the business in this context I mean by reference to an analysis of what the business is in fact doing. It is only by identifying what the nature of the business is in that way that one can determine the extent to which any given expenditure can be said to be for the purposes of that business”.
The principle of a clear link was further underlined by the European Court of Justice in the case of BLP Group plc. See VIT62100.
This case stated that in order to confer a right to deduct the goods or services supplied to the claimant must have a direct and immediate link with the taxable transactions carried out by the taxable person claiming the right to deduct.
You can apply the business purpose test (see VIT10200) in many situations to decide if a cost and a business activity are connected. When you apply the test to a limited company you must work out:
- what are the business purposes of the company and
- what are the private purposes of its directors and controlling officers.
Other points to consider
Sometimes a company buys goods or services which are essentially for the private purposes of its directors. Input tax cannot be claimed when the relevant goods or services are supplied to the directors as individuals because of the supply rule. See VIT11500. If the supply is to the company the business purpose tests must be satisfied for the VAT to be input tax. See Kingsnorth Developments Ltd at VIT61080.
The fact that goods are:
- owned by a company rather than an individual; and
- shown as assets on the balance sheet
does not in itself mean that those goods are used for the purpose of the business.
Where there is no obvious relationship between the business activity and the ownership of items such as yachts or aircraft you should think about whether these items are principally for the private use of directors. See VIT25000 which deals with mixed business and other use.
Repair and upkeep of assets
Input tax on the repair and upkeep of goods used for business purposes may be recovered in proportion to the level of business use even if the goods themselves are not business assets. A claim to input tax on repair and upkeep does not make the goods themselves liable to VAT if they have been treated as private assets. See Bakcsi (VIT61080).
Wholly private assets
Someone buying goods for both business and private use may choose to keep them as wholly private assets and make no claim to input tax. This means those goods do not become liable to VAT if they are sold later.
VAT incurred on costs that support non-business activities cannot be claimed as input tax. VAT Business/Non-BusinessVBNB20000. gives guidance on which activities are to be treated as business. This question has to be considered before you think about whether input tax can be claimed. You will also need to refer to VIT25000 which deals with mixed business and non-business use.
Activities outside the scope of UK VAT
Input tax can be claimed if an activity is outside the scope of UK VAT because of the place of supply rules but would have been taxable if supplied within the UK. If the business makes both exempt and outside the scope supplies you should refer to PE Partial Exemption Guidance. VAT incurred on exempt activities or “exempt input tax” satisfies the business purpose test. However, the partial exemption rules apply before any claim to input tax can be made.
Some tax avoidance schemes rely on making supplies before registration by issuing an invoice or receiving payment but incurring the costs, including tax, of making those supplies after registration. Schemepanel Trading Ltd at VIT61080 gives more on how to deal with this.