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HMRC internal manual

VAT Partial Exemption Guidance

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HM Revenue & Customs
Updated
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Partial Exemption methods: example paragraphs: early and defining paragraphs

Opening paragraph

Consideration has been given to your request dated [insert date] in which you seek approval for the use of a [partial exemption]* special method to determine your recoverable input tax and your declaration dated [insert date] that to the best of your knowledge and belief your proposals are fair and reasonable. The method is set out in this letter [and the attached appendix /appendices] and the Commissioners approve that method (and hereby record their approval of it) subject to the conditions below.

*omit the words ‘partial exemption’ if the letter is made under regulation 102ZA and it includes an agreement as to how business use of VAT is to be determined but it does not describe how taxable use of input tax is to be determined because the business is currently fully taxable.

Scope of the method

For a method letter not made under regulation 102ZA that is issued to a business that makes both business supplies and has non-business activities i.e. it does not include an agreement as to how business use of VAT is to be determined (see PEXXXX for more about regulation 102ZA):

This approval applies only to the partial exemption special method (‘PESM’). [Insert name] has to ensure that only input tax incurred on goods and services used for business purposes is included in the calculations. VAT incurred directly or indirectly for non-business purposes must be excluded before the PESM calculations are made.

For a method letter not made under regulation 102(1A)(b) i.e. it does not include an agreement as to how use is to be determined for the purposes of regulation 103 supplies (see PE3900 for more about regulation 103):

This method provides for the deduction of input tax only in respect of taxable supplies made within the UK. The deductible proportion of input tax relating to the following supplies:

any supply made outside the UK that would be a taxable supply if made within the UK; or

any supply specified in an order under the Value Added Tax Act 1994 (as amended) section 26(2)(c)

must be calculated separately under Regulation 103 of the Value Added Tax Regulations 1995 (as amended).

For a letter made under regulation 102(1A)(b) i.e. it includes an agreement as to how use is to be determined for the purposes of regulation 103 but does not include an agreement as to how business use of VAT is to be determined for the purposes of regulation 102ZA:

This method has been approved under regulation 102 of the Value Added Tax Act Regulations 1995 (as amended). It incorporates input tax attributable to foreign and specified supplies as defined in regulation 103 Value Added Tax Regulations 1995 (as amended).

For a letter made under regulation 102ZA i.e. it includes an agreement as to how business use VAT is to be determined for the purposes of regulation 102ZA and how use is to be determined for the purposes of regulation 103. N o t e - it is not permissible to approve a method under regulation 102ZA unless it also includes input tax attributable to foreign and specified supplies as defined in regulation 103 Value Added Tax Regulations 1995 (as amended).

This method has been approved under regulation 102ZA Value Added Tax Regulations 1995 (as amended). It incorporates VAT attributable to non-business activities as defined in section 24(5), Value Added Tax Act 1994 (as amended) and input tax attributable to foreign and specified supplies as defined in regulation 103 Value Added Tax Regulations 1995 (as amended).

For a letter made under regulation 102ZA that only includes an agreement as to how business use of VAT is to be determined for the purposes of regulation 102ZA because the business is currently fully taxable i.e. it did not incur any exempt input tax in its current or immediately preceding (if any) tax year or registration period.

This method has been approved under regulation 102ZA of the Value Added Tax Regulations 1995 (as amended). It incorporates only VAT attributable to non-business activities as defined in section 24(5), Value Added Tax Act 1994 (as amended).

If you incur exempt input tax on or after the date from which this approval has effect a notice under regulation 102(B) Value Added Tax Regulations 1995 (as amended) will automatically take effect from the date you incur such exempt input tax. This notice will require you to calculate the difference between

  1. the attribution of input tax to taxable supplies made by you in any prescribed accounting period or longer period, and
  2. an attribution which represents the extent to which the goods or services are used by you or are to be used by you in making taxable supplies

and account for the difference on the return for that prescribed accounting period or on the return on which that longer period adjustment is required to be made.

Duration of the method

NON VAT GROUPS:

You must use this method to calculate your recoverable input tax with effect from [insert date] and must use it until such time as the Commissioners approve or direct the termination of its use. You should make proposals to this office for a new method if this one no longer results in a fair and reasonable recovery of input tax.

This approval is given in the context of your current business structure and trading patterns as advised by you to this office. Should there be any change in the structure of your business and/or trading patterns that prevent this method from giving a fair and reasonable recovery of input tax, you should inform this office of the change or changes immediately in writing, and comment on how the changes affect the operation of this method. Planned changes in the above-mentioned matters should, wherever practicable be notified to this office at least 30 days in advance of implementation and in any event, no later than upon implementation. [The changes referred to include any changes in the business activities and/or trading patterns of the sectors1.]

You should also inform this office in writing immediately if any connected company commences or re-commences trading with the business. For the purposes of this letter any question as to whether a person is connected shall be determined in accordance with Section 1122 of the Corporation Tax Act 2010.

An earlier date will be specified where a Notice is served as a result of an incorrect declaration, see PE43300.

VAT GROUPS:

You must use this method to calculate your recoverable input tax with effect from [insert date]. You must use it until such time as the Commissioners approve or direct the termination of its use. You should make proposals to this office for a new method if this one no longer results in a fair and reasonable recovery of input tax.

This approval is given in the context of your current business structure and trading patterns as and is based on information [name of VAT group] has provided to the Commissioners. Should there be any changes in the structure of your business and/or trading patterns, which prevent this method from giving a fair and reasonable recovery of input tax, you must notify this office in writing promptly and comment on how the changes affect the operation of this method. If the only change to the current business structure is a change to the name of a company, the trading name of a company [or a sector/sub-sector], this approval remains extant as if the new name was substituted for the old. I would ask you to inform this office of the change or changes in writing should:

  • there be any material change in the structure of the business;
  • any member of [VAT group name] cease, commence, or re-commence trading, or commence a new type of business activity;
  • there be any changes in the trading patterns of any member of the VAT group, or any other changes affecting the VAT group, that might reasonably be considered to create a risk that the approved method will no longer produce a fair and reasonable recovery of input tax; [the changes referred to include any changes in the business activities of the sectors 2] or
  • any group undertaking commence or re-commence trading with the VAT group. For the purposes of this letter a group undertaking shall have the same meaning as in section 1161 of the Companies Act 2006.

An earlier date will be specified where a Notice is served as a result of an incorrect declaration, see PE43300.

Meaning of terms

For the purposes of this method the words used shall have the meanings defined in this letter [or in Appendix ‘X’ if appropriate], or if not defined here [or in Appendix ‘X’ if appropriate], their meaning as defined in the Value Added Tax Act 1994 (as amended) and the VAT Regulations 1995 (as amended), or if not defined there, their normal everyday meaning.

It is suggested that if an appendix is used it lists all definitions such as taxable and exempt supplies [see below], ‘transaction’, ‘headcount’, ‘attribution’, ‘allocation’ etc… as they relate to the particular business and method.

Definition of taxable supplies

For method letters incorporating an agreement as to how use is to be determined for the purpose of regulation 103 and method letters incorporating non-business VAT made under regulation 102ZA.

Where this method refers to ‘taxable supplies’ it should also be taken to include:

  1. any supply made outside the UK that would be a taxable supply if made within the UK; and
  2. any supply specified in an Order made under section 26(2)(c) of the Value Added Tax Act 1994 (as amended).

Definition of exempt supplies

To be included in all PE and combined method letters.

Where this method refers to ‘exempt supplies’ it should also be taken to include any supply made outside the UK, which would be exempt if made inside the UK, other than any supply specified in an Order made under section 26(2)(c) of the Value Added Tax Act 1994 (as amended).

Definition of mixed-use VAT

Only to be included if the method has been approved under regulation 102ZA i.e. it incorporates a business/non-business calculation:

Where this method refers to ‘mixed-use VAT’ it means VAT on a supply which is used, or to be used, in making supplies in the course or furtherance of your business other than supplies made under para 5(4) of schedule 4 to the Value Added Tax Act 1994 (as amended) and which is also used, or to be used, in any non-business activity.

Tax year

Your tax year begins on [insert date] and ends on [insert date].

Attribution

For non-sectorised methods:

In each prescribed accounting period you will:

  1. identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in making taxable supplies; the input tax thereon is recoverable;
  2. identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in [making exempt supplies or in] carrying on any activity other than the making of taxable supplies; the VAT thereon is not recoverable;
  3. [for methods approved under regulation 102ZA i.e. methods incorporating a business/non-business apportionment] determine the recoverable amount of any remaining mixed-use VAT and/or non-attributable input tax by multiplying that VAT by the following formula[s]:-
  4. [for methods not approved under regulation 102ZA i.e. methods not incorporating a business/non-business apportionment] determine the recoverable amount of any remaining, non-attributable input tax by multiplying that input tax by the following formula[s]:-

For sectorised methods:

In each prescribed accounting period you will:

  1. identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in making taxable supplies; the input tax thereon is recoverable;
  2. identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in [making exempt supplies or in] carrying on any activity other than the making of taxable supplies; the VAT thereon is not recoverable;
  3. [for methods approved under regulation 102ZA i.e. methods incorporating a business/non-business apportionment] identify all supplies, acquisitions and imports you receive which are used, or to be used, in making [taxable and exempt supplies] [ taxable and exempt supplies and in undertaking your non-business activities] [ taxable supplies and in undertaking your non-business activities] and which are used, or to be used, exclusively within a single sector; the VAT thereon shall be allocated in full to that sector;
  4. [for methods approved under regulation 102ZA i.e. methods incorporating a business/non-business apportionment] identify all supplies, acquisitions and imports you receive which are used, or to be used, in making [taxable and exempt supplies] [ taxable and exempt supplies and in undertaking your non-business activities] [ taxable supplies and in undertaking your non-business activities] and which are not used, or to be used, exclusively within a single sector; the VAT thereon shall be allocated between the sectors [insert details from allocation methods below].
  5. [for methods not approved under regulation 102ZA i.e. methods not incorporating a business/non-business apportionment] identify all supplies, acquisitions and imports you receive which are used, or to be used, both in making taxable and exempt supplies and which are used, or to be used, exclusively within a single sector; the input tax thereon shall be allocated in full to that sector;
  6. [for methods not approved under regulation 102ZA i.e. methods not incorporating a business/non-business apportionment] identify all supplies, acquisitions and imports you receive which are used, or to be used, both in making taxable and exempt supplies and which are not used, or to be used, exclusively within a single sector; the input tax thereon shall be allocated between the sectors [insert details from allocation methods below].

Creating sectors

For the purposes of this approval your business shall be considered to consist of the following sectors: [or: the sectors described in Appendix ‘Y’].

If a company name or similar forms part of the definition, the definition should include the words ‘and its successor organisations’. For example, ‘the ABC Limited sector means all activities carried out by ABC Limited and its successor organisations’.