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HMRC internal manual

VAT Partial Exemption Guidance

Partial Exemption methods: simplifcations to the Standard Method: in-year provisional recovery rate


What were the old rules?

Under the old rules (prior to 1 April 2009), a business operating the standard method was required to calculate the percentage of input tax it could recover in each VAT return. These recovery percentages were provisional because, at the end of the year, the business had to calculate a recovery percentage for the whole year which it then used to finalise the amount of recoverable input tax. It then accounted for any under or over-recovery of input tax by way of an annual adjustment.

What are the new rules?

The new default position is that a business uses its previous year’s recovery percentage to determine the provisional recovery of residual input tax in each VAT return, which is then finalised as normal by way of an annual adjustment. The finalised annual recovery percentage is then used as the provisional recovery percentage for the next year and so on.

Example: A business has a partial exemption tax year that runs from 1 April to 31 March. For the year ending 31 March 2009, its annual recovery percentage was 60 per cent. For its VAT returns in the tax year commencing 1 April 2009 it may now provisionally recover 60 per cent of its residual input tax, thereby saving the need to calculate separate recovery percentages for each return. At the end of the year it must perform an annual adjustment calculation in the normal way, using actual figures for the year, to account for any under or over-recovery of input tax.

Are the new rules compulsory?

No, if it prefers, a business may continue to operate the old rules and calculate separate recovery percentages for each of its VAT returns. There is no need to notify HMRC. The only condition is that a business must consistently apply either the new rules or the old rules in any given tax year.

What do I need to consider before deciding which to apply?

The main risk of using the previous year’s recovery percentage is if the actual proportions of taxable to total supplies change significantly during the year. This could result in an unexpected under or over-recovery of input tax at year-end when the annual adjustment is calculated. On the other hand, it has the advantage of smoothing out seasonal fluctuations in turnover and could assist short term (ie until year-end) cash-flow planning. The provisional recovery option is particularly helpful for businesses whose partial exemption recovery rate is relatively steady from one year to the next.

How will HMRC keep track?

The approach adopted by a business will be determined by the way it completes its first VAT return of any given tax year. If it calculates recovery of input tax by reference to the value of supplies made in that period, it shall be deemed to have opted to calculate separate recovery percentages for all returns falling within that tax year. In all other situations, it shall be deemed to have opted to calculate input tax recovery by reference to the previous year’s annual recovery percentage which is the default position.

What if I was de minimis in my previous tax year?

The provisional recovery is determined by reference to the previous year’s recovery percentage and not according to whether a business could recover all of its input tax under the de minimis provisions. Please note that this will be reviewed in 2009-10 when simplification of the de minimis rules is considered.

What if I was required to carry out a standard method override calculation in my previous tax year?

You should calculate provisional recovery on the basis of the annual recovery percentage before the application of the override. This is because the override is usually triggered by unusual events that are not representative of the normal trading pattern of a business. However, it will still be necessary to consider the override at the year-end.