Partial Exemption principles: attribution
Definition of attribution
Attribution is the process of determining how much of the input tax incurred by a business relates to taxable supplies made or to be made. We attribute supplies received rather than purchase invoices. It should be borne in mind that several supplies can be included on one invoice or a single supply can be split over several invoices.
There are two main stages to this process. These are:
- direct attribution; and
- apportionment of the remaining tax.
This is the identification of input tax on supplies that are wholly used, or to be used in making taxable supplies or wholly used or to be used in making exempt supplies. The tax used in making taxable supplies can be recovered in full, whereas the tax used or to be used in making exempt supplies cannot. Whatever input tax is non-attributable is carried forward to the next stage of the process. There is no provision for making ad hoc splits at this point, even if the full final use is known.
Whether any particular supply received can be directly attributed is a question of fact to be decided on the particular circumstances of each case. In order to make these decisions it is useful to understand two additional concepts that are used in categorising input tax. The cases discussed in PE21500 - Attribution case law - will further illuminate these issues.
Supplies can be directly attributed to taxable if they have a direct and immediate link to one or more taxable supplies made or to be made, and to neither any exempt supplies made or to be made nor to the business as a whole, so as to be a cost component of those supplies.
Direct and immediate link
This concept covers the degree of nexus required between a supply received and a supply made for the former to be a cost component of the latter.
This 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 and costs incurred must therefore be linked to the immediate supplies made using them. What the business then does with revenues generated by those supplies is irrelevant.
In general there will be a temporal link, with the input coming 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. The former mostly occurring where goods have been in stock for a long time, the costs were initially speculative or there is a change of use. The latter mostly occurring where there are obligations on the supplier under a contract, which have not been fulfilled when that contract is signed, and which 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 as they are cost components of the business as a whole. Unless all supplies that costs incurred have a direct and immediate link with are either taxable or exempt the costs will not be directly attributable.
This is a concept that is referred to in the most basic definition of what VAT is in the principal VAT Directive (2006/112/EC) (see PE11000 - EU law). Input tax is deductible in so far as it is incurred on supplies that are cost components of transactions bearing 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. Thus all business expenses are cost components of some or all of the business’s supplies, with general overheads being cost components of all the business’s supplies.
Direct costs such as goods for resale, transport of those goods and selling expenses (e.g. salesmen’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.
In deciding what supplies received are cost components of what supplies made, and to what degree, commercial reality is always relevant.
Supplies received as a consequence of supplies made
In general, supplies received as a consequence of making an output transaction, rather than as part of the normal cost components of making the supply, are not cost components of that output transaction. There is thus no direct and immediate link and such costs will normally be non-attributable. These costs include such things as defending litigation for alleged shoddy work or poor advice given.
Intention, change of intention and wasted costs
As any entitlement to deduct arises when VAT is incurred, it is the business’s intention at that point that determines how it should be attributed. If that intention is subsequently frustrated so that the costs are wasted and put to no use in the business then there is no change to this initial entitlement. If, however, costs are put to another use within the business then the clawback and payback rules may apply. These are fully explained in PE61000 - Changes in intention or use.