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HMRC internal manual

VAT Partial Exemption Guidance

Other Partial Exemption issues: Lennartz treatment: can Lennartz output tax exceed input tax deduction under the PESM?

For fully taxable taxpayers, the total output tax charge on deemed supplies of a Lennartz asset over its commercial life cannot exceed the total amount recovered as input tax. While HMRC would not in general expect this to be any different for partially exempt traders, it is possible that adoption of the Lennartz treatment will lead to output tax declarations exceeding input tax deduction. The most likely reason for this occurring is failure to agree to a PE method that achieves a fair and reasonable apportionment for the business as a whole (possibly due to the business trying to cherry pick the Lennartz treatment areas while not addressing distortions elsewhere in their method). HMRC are always willing to negotiate new fair PESMs when circumstances change but do not guarantee that adoption of the Lennartz mechanism by partly exempt businesses will not leave them worse off and will not consider changes to PESMs that do not achieve an overall fair result to avoid such a result.

Some advisers have attempted to draw parallels between the Lennartz treatment and the treatment under the Supply of Services Order (SI 1993/1507) (which specifies that output tax payable will not exceed input tax deductible) and to argue that this means that the total output tax charge cannot exceed input tax times the recovery rate (as amended under the CGS in subsequent intervals) for PE traders with Lennartz assets. However direct comparison between the SOSO and the deemed supply under Schedule 4 paragraph 5 is not meaningful. It is important to recognise that the vires for the two are different. While both stem from the principal VAT Directive (2006/112/EC), the Lennartz charge is an output tax charge under Article 26(1)(a) (formerly Article 6(2)(a)) whereas the SOSO charge is an input tax adjustment under Article 185 (formerly Article 20(1)(b)).

If the PE method applicable at the time the input tax was incurred, the method of establishing use in subsequent intervals for CGS purposes and the method of valuing the taxable deemed supplies are all fair, then the overall neutrality of adjustments is assured.