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HMRC internal manual

VAT Input Tax

Is it input tax: the link to supplies

Cost components
Direct and immediate link 

Cost components

Input tax is deductible when it is incurred on supplies that are cost components of transactions which carry the right to deduct associated input tax.

In normal accountancy practice all costs incurred are set against income receivable to work out a net profit. Therefore all business expenses are cost components of some or all of the business’s supplies. General overheads are cost components of all the business’s supplies.

Direct costs such as:

  • goods for resale;
  • transport of those goods; and
  • selling expenses such as sales staff’s commissions

are generally set against the sales they relate to in a trading account leading to a gross profit. General overheads are then set against gross profit so as to arrive at net profit (or loss) for the business.

Commercial reality is always relevant when deciding what supplies received are cost components of what supplies made, and to what extent.

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Direct and immediate link

This concept covers the level of connection needed between a supply received and a supply made for the former to be a cost component of the latter.

It prevents any ‘look through’ being applied to intervening transactions in favour of the ultimate purpose of the business involved. VAT is a transaction based tax. Therefore costs incurred must be linked to the immediate supplies made using them. It does not matter what the business then does with revenues generated by those supplies.

In general there will be a time based link. The input will come before, but not greatly before, the output that it is leading towards. It is possible, however, for the input to be incurred either well before the output is made, or after the output is made, and still have a direct and immediate link.

An input can be incurred well before the output is made where:

  • goods have been in stock for a long time;
  • the costs were initially speculative; or
  • there is a change of use.

An input can be incurred after the output is made where:

  • there are obligations on the supplier under a contract;
  • the obligations have not been fulfilled when that contract is signed; and
  • the obligations require further costs to be incurred at a later date.

It is possible for costs incurred to have a direct and immediate link with:

  • more than one supply; or
  • with one or more supplies; and
  • with the business as a whole.

General costs have a direct and immediate link to all of a business’s supplies because they are cost components of the business as a whole.

See BLP Group plc at VIT62100.