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HMRC internal manual

VAT Partial Exemption Guidance

HM Revenue & Customs
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Partial Exemption powers: directing a special method


Directing a special method

The Commissioners have the power to direct the use of a partial exemption special method and also to direct the termination of the use of a special method, effectively requiring the business to adopt the standard method. These powers are given in regulation 102(1) and 102(3) respectively, of the VAT regulations 1995.

Where the use of the standard method or a special method gives rise to an unfair recovery of input tax, and HMRC have been unable to persuade the business to propose a suitable method, it is appropriate to consider using these powers. Where large amounts of tax are at stake, or the business is particularly complex, it may be appropriate to consider serving a special method override notice (SMON) on the business instead. Further details concerning SMONs can be found in PE51000.

In order to be able to determine a method that will produce a fair and reasonable result, the same types of information are required as when considering whether to approve a special method. If a business does not provide the required information when requested, the use of the Commissioners powers to require production of documents should be considered. These are fully discussed in V1-24B Officers’ Information Powers.

However, both the direction of a special method and the termination of a special method require the prior written approval of Partial Exemption Team. Officers should consult with the Team or the appropriate PESO as soon as it is thought that a direction may be a possible course of action.

A direction can only have effect from the date on which it is made or from a specified future date, and this is set out in Regulation 102(4).

Whilst a method may be directed from a current date, it is normally appropriate to give a business notice of a direction unless the tax at risk is significant or forestalling is likely. This will allow the business to make any required system changes in good time before the method takes effect.

It is also important to realise that should the Commissioners decide to exercise these powers and make a direction, the business may appeal to a Tribunal. It would then become necessary to demonstrate to a Tribunal that the directed method did secure a fair and reasonable attribution of input tax to taxable supplies. The mere fact that a different method may reduce the amount of input tax recoverable by a business to a level that better reflects use is not, in itself, sufficient to justify the making of a direction. The method that the business is directed onto has to be a fair and reasonable one, and this will need to be demonstrated to the Tribunal’s satisfaction by the appropriate evidence.

Direction of the termination of a method

To direct the termination of a special method is in effect to direct the business to use the standard method. In such circumstances HMRC will need to demonstrate that the standard method is fair and reasonable for that business. It is not sufficient to rely on the override to ensure a result that reflects use. Indeed, if it is anticipated that an override calculation will be required when a business is directed onto the standard method, then the standard method cannot be said to give a fair and reasonable result.

In Merchant Navy Officers Pension Fund Trustees Ltd and Merchant Navy Ratings Pension Fund Trustees Ltd (VTD 14262) the tribunal agreed with the Commissioners that the method in place was not fair and reasonable but also concluded that the standard method, to which the appellant defaulted, was even less appropriate. Accordingly it found that the withdrawal of approval of the special method should not have been made without approval or direction of an alternative and the Commissioners’ decision was set aside.

Approach to take

When considering a direction, it is important that the Commissioners’ concerns with the current method are set out clearly. Unless there are exceptional circumstances, the business should also be given sufficient opportunity to make representations. It is equally important that sufficient evidence is obtained to demonstrate that the current method is not fair and reasonable, but that the directed method will be.

In BMW (GB) Ltd (VTD 14823) the Tribunal held that the decision by the Commissioners to direct the business to use a special method had been a reasonable one. In drawing this conclusion, the tribunal identified the following actions taken. The Commissioners:

  • carefully considered a number of proposed methods put to them, explained why they were unacceptable and invited new proposals;
  • entered into discussions and correspondence with the appellant in relation to their proposals; and
  • indicated that unless they could agree a method they would be prepared to make a direction and waited before making the direction.
  • In summary, the Commissioners acted reasonably throughout, exercising patience and tolerance in the discussions and correspondence.

In all cases where the business’s current method does not reflect the use of the input tax bearing costs, officers should attempt to persuade the business to propose an appropriate new special method. Where this is not possible and you consider that a direction is appropriate then Partial Exemption Team’s approval must be obtained to direct an alternative special method. Only local consideration of the facts of each case can determine whether a direction should be sought or whether the existing method can be left in place pending the approval of a new special method. However, officers should be alert to the possibility of stalling by businesses or their advisers. The Commissioners must make every appropriate effort to resolve the concerns of a business, but must also have regard to the taxpayer in general.

Referrals to Policy team

Where you consider that a business’s method does not produce a fair and reasonable result, and you have taken all reasonable steps to persuade the business to change to a more suitable method, you should first discuss the case with your local PESO. If they believe that a direction would be an appropriate course of action, they will submit the case to PE team or to the appropriate policy PESO, giving full details. These should include:

  • a copy of the business’s existing method;
  • details of why the current method does not produce a fair and reasonable result;
  • an estimate of the revenue saving if the suggested method were to be operated in place of the existing method;
  • a history of recent PE discussions, including copies of relevant correspondence, notes of meetings, telephone conversations etc; and
  • details of the method that you propose to direct and any alternatives considered.

IF PE team decide that a direction is appropriate, they will advise on the wording of the direction and provide the necessary written authority to serve it.

After the direction is made

The making of a direction will often not be the end of the process. This is especially so because businesses always continue to evolve.

What is a fair and reasonable method at the time of direction may not be so at a later date. Also there will always be a range of methods that can be said to be fair and reasonable. If the business proposes such a method there is no fundamental reason for HMRC not to approve it.

However, PE team must always be consulted before any method that has been directed is replaced by a new special method. If the business has appealed against the direction of the method, care must be taken not to compromise HMRC’s position over costs when approving the new method. These issues are further discussed in relation to special method override Notices in PE51000.