Beta This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

VAT Partial Exemption Guidance

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 Member States nor adversely affect intra-community trade.

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


  • 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.

The application of fiscal neutrality to PE was confirmed in the decision of the ECJ in the case of Securenta ECJ C-437/06 

Paragraphs 36 and 37 of the judgement in that case stated:

In particular the measures which the Member States must are required to adopt must comply with the principle of fiscal neutrality on which the common system of VAT is based.

Accordingly, the Member States must exercise their discretion in such a way as to ensure that deduction is made only for that part of the VAT proportional to the amount relating to transactions giving rise to the right to deduct.