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HMRC internal manual

VAT Partial Exemption Guidance

Partial Exemption methods: the special method document


Form of a method

A special method details how a business is to determine its recoverable input tax and it will be in the form of a written document. It is a series of steps, which taken together, and in the prescribed order, produce a value for the amount of input tax which a business may deduct.

However, in Barclays Bank PLC [VTD 5616] the Tribunal quoted an Inland Revenue case: Cape Brandy Syndicate v Inland Revenue where the judge said:

“…in a taxing Act one has to look merely at what is clearly said. Nothing is to be read in nothing is to be implied. One can only look fairly at the language used…”

Both businesses and HMRC therefore have the right to rely upon the wording in the method document. However, after a method is approved, if it transpires that a business has deliberately withheld relevant information, then they may not be able to rely on that method, since it was approved on the basis of the agreed facts at the time of approval.

For any methods approved from 01 April 2007, which will require a declaration (see PE43000 - The Declaration), HMRC will be able to serve a SMON if it can be shown that a business has deliberately withheld information.

In order for there to be a final proposal (which HMRC then approves), there must first be agreement between the parties on the detail of that proposal, and this often involves changes on both sides. It is important to emphasise that the wording of the method must reflect what has actually been proposed by the business and approved.

In many cases, if there is any ambiguity in the wording of a special method approval letter, it will be decided in favour of the business, rather than HMRC. This is because the Department is expected by the courts to have the expertise to ensure that the wording of a special method approval letter is correct.

Special method letter requirements

All letters will be different since all circumstances will be different. However there are some areas that should always be included. These are:

  • the business’s name and VAT number;
  • requirement that any changes in business (or VAT group membership) should be notified in writing;
  • the business’s tax year;
  • the provision for direct attribution;
  • the method of allocation to sectors (if applicable), including a provision for direct allocation of residual input tax where it is only used by one sector;
  • the method of apportionment of residual input tax;
  • how many decimal places calculations should be rounded to;
  • provisions to exclude any distorting factors, other than those already set out in Regulation 101(3); and
  • the requirement to carry out an annual adjustment.

Avoid including anything in a letter that is unnecessary because it is covered in the Regulations. For example, do not include the de minimis rules in the letter. If you do, the law may change but not affect your business, since he has to abide by those set out in his special method letter.

Direct attribution

Any special method must include provision for the direct attribution of input tax. Any input tax on goods or services that wholly relates to taxable supplies is reclaimable in full, and any that wholly relates to exempt supplies is not reclaimable. This direct attribution must form a part of any special method. Any input tax that is incorrectly treated as residual when it could be directly attributed may produce an unfair result.

Calculation of the recoverable amount

UK and EC law requires a business to determine the amount of input tax that is recoverable; and not to assume that all is recoverable except for any input tax they can identify that is irrecoverable.

If a business’s method of apportionment is a transaction count and it makes 100 transactions in a period, 70 of which are taxable, 30 that are exempt, the calculation must produce a result of 70% recoverable, not a result of 30% irrecoverable. Accordingly, the numerator (top part of the fraction) should always be in respect of taxable supplies.

As well as being incorrect in law, treating everything as recoverable and identifying input tax to disallow is likely to lead to over recovery. Although the reverse is also true, the business is in a much better position than HMRC to react if the method is not producing a fair and reasonable result.


Special methods should not allow rounding up to the next whole number in the recovery percentage. Until the 2005 Budget, HMRC allowed special methods based on output values and using a single calculation to be rounded-up to the next whole number. However, for all new special methods approved or directed on or after 1 April 2005 we will only allow rounding to two or more decimal places. This policy will also apply to existing special methods as and when they are reviewed or updated.

Incidental and distortive supplies

When considering the acceptability, or otherwise, of a special method, you will need to be alert for elements that could distort the apportionment calculation. This distortion may be in favour of either HMRC or the business, but either way it will prevent a fair and reasonable apportionment of non-attributable input tax. The most common distortive supplies are those that are excluded from the standard method under Regulation 101(3). These include capital goods used in the business, some incidental supplies relating to land and finance and self-supplies. Such supplies are also excluded from special methods by virtue of Regulation 102(2). Further detail on what is meant by ‘incidental’ is included in PE32000.

A business may make supplies that are distortive, in that including them causes an otherwise appropriate method not to reflect use, but this does not automatically mean that they are incidental. They may be a fundamental part of the business’s activities and/or use significant amounts of residual input tax bearing costs. Excluding them completely might therefore cause a method not to reflect use.

Methods that are not based on output values may also be affected by distortions. A transaction based method for a financial advisor receiving exempt commissions and giving taxable advice will almost certainly be distorted by the inclusion of the sales to staff from the sweet trolley! Whatever the basis of the apportionment calculation, elements that could distort it should be excluded and the approval letter should specifically address this.

Distortive elements should normally be excluded from a special method. However, where distortive supplies also use significant amounts of residual input tax it may be necessary to find an alternative method of dealing with them. For example, an output values based method might specify that any supply exceeding £10,000 should be treated as though it were £10,000 or that some supplies are treated as though they were a percentage of their actual value.