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HMRC internal manual

VAT Partial Exemption Guidance

HM Revenue & Customs
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Consideration of Partial Exemption (PE) special methods: ‘Gaps’ in special methods

It is important to ensure that any approved special method takes into account all the activities of a business and therefore all of the input tax incurred by it. However, where a proportion of the residual input tax is not addressed by the method at all then there is said to be a ‘gap’ in the method. Most often such a gap occurs where input tax is allocated to a business activity or sector, but the method does not specify how that input tax shall be apportioned.

The issue arose in the case of the University of Sussex (VTD 16221). The Tribunal decided that as a matter of law, businesses must have the right to deduct a portion of any input tax that is partly incurred for deductible purposes and their method must therefore be interpreted in a way that covers any apparent ‘gaps’.

Regulations 102(5), (6) and (7), VAT Regulations 1995, brought in by the 2005 budget, specify that gap input tax should be recovered according to the use, or intended use of the tax bearing costs on which the gap input tax is incurred.

However, a gap still represents a flaw in any special method. Where a gap has occurred in a method, you should encourage the business to propose a new method and, where fair and reasonable proposals are not received (for the whole method), you should consider whether a direction is appropriate (see PE52000 - Directing a special method).