PE23500 - Partial Exemption principles: Fiscal neutrality and PE

Fiscal neutrality is a key feature of the VAT system. The VAT system must not distort competition between suppliers within the UK.

Fiscal Neutrality and Partial Exemption

For partial exemption (PE), fiscal neutrality means that a taxable person can deduct all the input tax incurred and used in making recoverable supplies and no more.

So when a taxable person who is partly exempt enters the chain of transactions, the tax burden consists of

• any output tax charged on supplies

plus

• the irrecoverable input tax

The VAT incurred on costs used in making exempt supplies cannot be deducted as input tax. So the taxable person who is partly exempt becomes a final consumer and is burdened with the non-recoverable input tax.