Partial Exemption methods: Regulation 103 - recovery of input tax attributable to foreign and specified supplies
As set out in PE11000 all EU member states must allow the deduction of input tax incurred on certain supplies made by businesses, both inside and outside the UK, that are not taxable supplies. The following details how this is enacted in UK legislation:
VATA 94 s26(2)
This section lists out the type of supplies made that carry the right to deduct associated input tax:
- s26(2)(b) states that supplies with a place of supply outside the UK that would have been taxable if they had been made inside the UK carry this right.
- s26(2)(c) states that any other supply that is specified by the Treasury in an order to that purpose will also carry this right.
The Specified Supplies Order 1999 (SI 1999/3121) is such an order. This is how UK law pulls in all the other instances where allowing deduction of input tax is required.
The Specified Supplies Order
This sets out the supplies that carry the right to deduct in articles 3 and 4, which reads as follows;
(a) which are supplied to a person who belongs outside the member States;
(b) which are directly linked to the export of goods to a place outside the member States; or
(c) which consist of the provision of intermediary services within the meaning of item 4 of Group 2, or item 5 of Group 5, of Schedule 9 to the Value Added Tax Act 1994 in relation to any transaction specified in paragraph (a) or (b) above,
provided the supply is exempt, or would have been exempt if made in the United Kingdom, by virtue of any item of Group 2, or any of items 1 to 6 and 8 of Group 5, of Schedule 9 to the Value Added Tax Act 1994.
- Supplies made either in or outside the United Kingdom which fall, or would fall, within item 1 or 2 of Group 15 of Schedule 9 to the Value Added Tax Act 1994 (investment gold).
The principal areas that this applies to are:
- financial supplies to persons belonging outside the member States,
- insurance supplies to persons belonging outside the member States, and
- supplies of investment gold.
- loans or insurance provided in respect of specific exports of goods to non-EU countries.
The mechanisms for allowing deduction of this input tax in the UK are regulations 103 and 103A. These allow that input tax incurred by a business on supplies that are used or to be used wholly or partly in making foreign or specified supplies.
“…shall be attributed to taxable supplies to the extent that the goods or services are so used or to be used expressed as a proportion of the whole use or intended use.”
The nature of regulation 103
This is a use-based regime. It requires a calculation that fairly reflects how the input supplies in question are used in the business, normally referred to as a proxy for use. There is no set proxy to be used so it is up to each business to do something that reflects his specific circumstances. If the result is fair and reasonable then the business’s chosen proxy for use is acceptable over the periods in question. If the result is not fair and reasonable then assessment action for the difference between the declared tax and a fair and reasonable result may be needed. The concept of “fair and reasonable” is discussed elsewhere in this guidance at PE33000 - Introduction to special methods.
The interaction of regulations 103 and 101
This section only applies to historic periods and remains here for reference purposes only. The of the scope of the standard method was widened as from 1 April 2009 so that it now deals with input tax on all supplies; unless it is dealt with separately under regulation 103A (Investment Gold).
Regulation 101 (the standard method) gives the default option for how the amount of input tax that is attributable to making taxable supplies in the UK is to be calculated. It is fully described in PE30500 - The standard method. As we have seen above, regulation 103 only addresses the attribution of input tax to supplies that are not taxable in the UK. The two together thus represent a coherent system for calculating the amount of input tax a business should recover.
In constructing his VAT account a business must first address recovery under regulation 103. Once he has done this, all so far unclaimed input tax is reconsidered under regulation 101. One important point to remember is that if a supply received relates only to exempt and regulation 103 supplies the remaining input tax will be attributed entirely to exempt within regulation 101 as the claimable portion has already been identified.
The House of Lords confirmed the relationship between regulations 103 and 101 in the case of Liverpool Institute for the Performing Arts (LIPA).
LIPA provided advertising and publicity services to a German company. The place of supply was Germany.
Regulation 101(2)(b) states:
“…there shall be attributable to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies”.
LIPA argued that the term ‘taxable supplies’ should include supplies made outside the UK which are not taxable supplies but which would be if made in the UK. They should therefore be included in the standard method calculation.
The House of Lords ruled that these supplies are not to be included in the numerator of the standard method calculation. The standard method is used to apportion input tax relating to taxable supplies made in the UK
The standard method calculation is based on taxable supplies over all supplies. The Court of Appeal looked at what is meant by the term ‘all supplies’. It concluded that as the numerator of the fraction excludes outside the scope supplies with the right to deduct, ‘an absurd result would follow if they were included in the denominator’. Therefore these supplies are taken out of the numerator and the denominator. However outside the scope with no recovery should remain in the denominator.
Agreeing regulation 103 proxies for use
VAT is a self-assessing tax and regulation 103 only requires an apportionment based on use. Because of this there is no need for HMRC to agree what proxy for use will be employed. We do however have the right to make such an agreement under our care and management of the tax. We will be bound by the terms of any express agreement made. So any agreements we have made in the past will run their course unless withdrawn and further agreements may be made. The Commissioners do not normally approve agreements on use under regulation 103 (see further below) unless a combined method is being approved under regulation 102.
Regulation 103 does not provide for annual adjustments as it is a simple use calculation rather than a method as referred to in regulation 107. However, if we agree a specific method by which regulation 103 attributions shall be calculated, and that method calls for annual adjustments, then those adjustments must be properly calculated and posted.
Unlike special or combined methods under regulation 102, there is no requirement to have a method that is formally approved. If we have checked a regulation 103 calculations and did not query it, made an assessment, or approved a voluntary disclosure, then that will not constitute an approval of a regulation 103 method going forward.
We should properly consider any requests to agree regulation 103 methods and carefully consider the business reasons for seeking them. The general rule should be that there is no need to make such agreements, unless a combined method (see below) is being approved when we should carry out a thorough review of the business’s input tax attribution.