Partial Exemption basics: partly exempt businesses and exempt input tax
Definition of a partly exempt business
A business is partly exempt if they are a taxable person and incur exempt input tax. We do not define becoming a partly exempt business in terms of the making of exempt supplies because the point of partial exemption is the restriction of input tax claims to the amount related to making supplies that carry a right to deduct. The making of exempt supplies may come years after the associated input tax was incurred. As the point of partial exemption is the restriction of input tax claims, the best way to define it is in terms of incurring that input tax.
A business becomes partly exempt when they first incur exempt input tax and ceases to be partly exempt when they go a whole tax year without incurring exempt input tax. There is more on this at PE37000 - Longer period adjustment.
The terms “taxable person” and “exempt input tax” are further explored below.
This term is defined in VATA 94, section 3(1) as a person who either is, or is required to be, VAT registered. VAT registration is further set out in Schedules 1, 2, 3 and 3A to the Act.
A point of particular relevance to this part of the guidance is that a business who is not required to be registered, but who makes supplies (whether within the scope of UK tax or not) that carry the right to deduct, has the right to register for VAT. So businesses can register for VAT, and potentially be partly exempt, whilst making no UK taxable supplies.
This area is further explained in VTAXPER.
In addressing partial exemption questions (including whether any business is partly exempt) the first step must always be to establish or confirm the liabilities of their supplies.
Supplies are exempt for VAT in the UK if they are otherwise within the scope of UK VAT, fall within any of the groups of Schedule 9 of the VAT Act as introduced by section 31 and do not fall within Schedule 8 to the Act.
For the purposes of partial exemption, supplies with a place of supply outside the UK, that would have been exempt if the place of supply were within the UK, are also considered exempt.
The supplies that fall within Schedule 9 are listed in an index that forms Part I of that schedule.
Exempt input tax
Exempt input tax is defined by regulation 99(1)(a) as follows:
“exempt input tax” means input tax incurred by a taxable person on goods imported or acquired by, or goods or services supplied to, him in so far as they are used by him or are to be used by him, or a successor of his, in making exempt supplies, or supplies outside the United Kingdom which would be exempt if made in the United Kingdom, other than any input tax which is allowable under regulation 102, 103 or 103A”
This definition gives us a concept of exempt input tax as all, or an undefined part, of the tax on any supply received that is destined to be a cost component of one or more exempt supplies. As with all decisions as to the status of input tax, the status of input tax as exempt is determined by the businesses true intentions at the time the input tax is incurred. As the annual adjustment requires all parts of the partial exemption process to be repeated, attributions can be reviewed at this time and changes in intention or use reflected.
This definition has only been in place since 18 April 2002. Prior to this the definition was worded so as to create an amount of tax rather than a concept. That amount being exempt by virtue of not having been attributed to taxable by whatever method the business was compelled or authorised to use.
This change was brought in alongside the override. Its purpose is to combat complications in calculating when the longer period starts in various circumstances.