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HMRC internal manual

VAT Partial Exemption Guidance

From
HM Revenue & Customs
Updated
, see all updates

Legal history and glossary of terms: glossary of terms

                                                   
                                                   

A

Allocation Allocation is the process of distributing costs on which residual input tax is incurred to specific sectors of the business.
   
Annual adjustment See longer period
Application A taxpayer who is partly exempt can make an application to ask HMRC to approve the adoption of a special method. Such an application should normally be made in writing.
  The application should set out the terms of the method the taxpayer is seeking to adopt, and the reasons why the proposed method is appropriate.
Apportionment Residual input tax must be apportioned to reflect the extent to which the goods and services on which it is incurred are used in making onward taxable supplies. The partial exemption method carries out this role.
Approve A special method can only be adopted if HMRC’ approve or direct its adoption by the taxpayer.
  Where a taxpayer makes an application to ask HMRC to approve a special method, HMRC will consider all the information provided and come to a decision about whether to approve or refuse the particular application.
Attribution Attribution is the process of identifying what input tax incurred by a taxable person relates to his taxable supplies and may therefore be deducted.
  The process normally includes direct attribution and apportionment and also includes allocation for sectorised methods.
   

B

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C

Capital goods scheme The capital goods scheme provides for adjustments to input tax incurred on capital items.
   
  The purpose of the scheme is to take account of changes in use of capital items between the making of taxable supplies and exempt supplies in subsequent intervals.
Capital items Capital items are certain high value capital expenditure in respect of computers and land/buildings that fall within the scope of the capital goods scheme.
Clawback The clawback provision applies where a taxpayer claimed input tax on goods or services and:
  * intended using them in making taxable supplies but in the event uses them, or forms an intention to use them in making exempt supplies, or both taxable and exempt supplies; or:
  * intended using them to make taxable and exempt supplies but in the event uses them, or forms an intention to use them to make only exempt supplies; and:
  * the change of intention occurs within six years of the beginning of the period covered by the VAT return in which the original intention was formed.
Costs Costs (purchases, inputs or expenditure) are goods and services supplied to (bought, received, self supplied or imported by) a taxpayer.
Cost components The cost components of a particular supply are all the costs that are actually incurred in making that supply. The goods or services in question must have a direct and immediate link to the particular supply.
  The ultimate aim pursued by the taxpayer is not relevant in this respect. Only the amount of input tax borne directly by the various costs components of a taxable supply may be attributed to taxable supplies.
   

D

De facto approval Although an application by a taxpayer for a special method should normally have been in writing and similarly, where HMRC approve the application, that would also normally be in writing, prior to 1 April 2005 they need not have been so.
   
  HMRC could give de facto approval to use a special method, providing the taxpayer knowingly adopted or sought to adopt a special method and HMRC were aware of what the taxpayer was doing or seeking to do.
De minimis A test designed to allow recovery of minimal amounts of exempt input tax.
Deduct A taxpayer is entitled to deduct any input tax incurred on costs that are used or to be used in making taxable supplies.
  The amount is entered on to the VAT return for the relevant prescribed accounting period or longer period and is thereby deducted from the amount of output tax payable to HMRC on any taxable supplies made by the taxpayer in that period.
  The balance is either an amount payable to, or receivable from, HMRC.
Directions HMRC are able to direct a taxpayer who is partly exempt to adopt, or terminate the adoption of, a particular special method. The power to direct is set out in regulation 102 of the VAT Regulations 1995.
  A direction under this regulation can only take effect from the date of the direction or some future date.
  In respect of capital items falling within the capital goods scheme, HMRC are able to direct the manner in which the extent of taxable use is determined in subsequent intervals.
  This power to direct is set out in regulation 116(2) of the VAT Regulations 1995.
Direct and immediate link The test for when a cost is linked closely enough with a taxable supply (or an exempt supply) to be a cost component of that taxable supply is whether there is a direct and immediate link.
  This is a more substantial test than there merely being a link (for most businesses all of their activities are, to some extent at least, linked).
Direct attribution The process of matching input tax incurred on a particular supply to an onward supply (or number of supplies of the same liability), which it uses exclusively.
  Input tax is therefore attributed to taxable supplies (and is thus recoverable) and exempt supplies (and is not recoverable, subject to de minimis). Any input tax used in making both taxable and exempt supplies is termed residual.
Distortive The term distortive describes any income, which, if included within the apportionment calculation of a partial exemption method would undermine its ability to produce a fair and reasonable outcome.
  The term is widely used and a distortive figure may involve an amount of VAT, the value of a supply, or any other figure that alters the recoverable percentage determined by the partial exemption method.
  It can relate to supplies made, costs received or changed business practice. Any distortive figures should be excluded from apportionment calculations.
  In the case of the standard method, the distortive figures are specifically excluded. In the case of special methods generally, distortive figures should be identified as such and excluded within the terms of the method.
  But, where HMRC approve or direct a special method based on outputs, no matter what the terms of that method and its exclusions are,
  the types of supplies that are specifically excluded from the standard method apportionment calculation must always be excluded from the special method apportionment calculation.
   

E

Effective date of registration The effective date of registration is the date from which the taxpayer is registered for VAT determined in accordance with Schedule 1, 2, 3 or 3A to the VAT Act 1994.
   
Exempt input tax Exempt input tax is defined in regulation 99(1)(a) of the VAT Regulations 1995. It is input tax incurred on costs insofar as they are used or to be used to make exempt supplies.
  Although the partial exemption method determines the value of taxable input tax, by implication it will also determine the value of exempt input tax.
  A taxpayer who is partly exempt is not able to deduct the exempt input tax unless it falls within the de minimis limits.
Exempt Supplies For the purposes of Partial Exemption this term has a wider meaning than it otherwise has in VAT. Exempt supplies are supplies that do not carry a right to deduct the input tax on costs that are used or to be used in making them. These are:
  * supplies within Schedule 9 of the VAT Act 1994 with no right to deduct;
  * outside the scope supplies with no right to deduct (these are supplies within the EC (and any non specified supplies made outside the EC) which would be exempt supplies if made in the UK).
   

F

Fair and reasonable The concept of fair and reasonable underpins all negotiated partial exemption methods. Indeed, the sole purpose of a partial exemption method is to translate the concept of a fair and reasonable tax recovery into reality.
   
  The constraints and conditions of partial exemption methods and the exclusion of incidental supplies and distortive figures from the calculations are designed to ensure this.
  The concept applies equally to both HMRC and the taxpayer. To be fair and reasonable, a partial exemption method must meet two basic conditions:
  * it should accurately reflect the extent that the goods and services on which input tax is incurred are actually used in making taxable supplies; and
  * its application should not be unduly burdensome for the taxpayer and its accuracy should be relatively easy to check by HMRC.
   

G

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H

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I

Incidental Under the standard method or an outputs based special method, in calculating the proportion of the residual input tax that can be reclaimed, certain prescribed incidental supplies must be excluded from the calculation used to determine the recoverable percentage.
   
  This is because the inclusion of the values of such supplies would unfairly distort the calculation.
  Although the value of an incidental supply may be of any size; high or low, it is always disproportionately high for the amount of residual input tax that is incurred in its making.
Input tax Input tax is defined in section 24 of the VAT Act 1994, as the VAT incurred by a person (who is, or is required to be registered for VAT) on costs which are used or to be used for the purpose of the business.
   

J

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K

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L

Longer period Partial exemption as a process takes place over the longer period. A taxpayer who is partly exempt must carry out a partial exemption adjustment at the end of the longer period.
   
  This is also referred to as the annual adjustment. The determination of the ‘longer period’ is set out in regulation 99(3) and normally consists of a tax year, although in certain circumstances it may be shorter than a tax year.
  The requirement to carry out a longer period adjustment is set out in regulation 107 of the VAT Regulations 1995.
   

M

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N

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O

Outputs Outputs (sales, exports, self supplies) are supplies of goods and services made (or deemed to be made) by the taxpayer. The value is net of any VAT chargeable.
   
Override When the standard method of attributing input tax to taxable supplies fails to produce a fair and reasonable deduction the override may apply, subject to the circumstances meeting certain criteria.
  This is set out in regulations 107A to 107E of the VAT Regulations 1995.
  When the override applies the taxpayer must post an adjustment calculated on used along with the longer period adjustment, or in the prescribed accounting period if there is no longer period.
   

P

Partial exemption Partial exemption concerns determining how much input tax relates to taxable supplies and can be deducted by a taxpayer who is partly exempt.
   
  It operates only after the taxpayer has determined how much of the VAT he has incurred is input tax and has any input tax that is blocked from deduction.
Partial exemption method A taxpayer who is partly exempt adopts a partial exemption method, whether the standard method or a special method, to determine the amount of taxable input tax which he is able to deduct.
  Any partial exemption method is acceptable provided it gives a fair and reasonable result.
Partly exempt A taxpayer who is partly exempt is one who incurs exempt input tax.
  A taxpayer who is partly exempt must make or intend to make taxable supplies in order to register for VAT. A taxpayer who is partly exempt will usually therefore also incur taxable input tax.
Payback The payback provisions apply where a business has not claimed input tax on goods and services because:
  * the intention was to use them in making exempt supplies but in the event they were used, or the taxpayer formed an intention use them in making taxable supplies or taxable and exempt supplies; or
  * the taxpayer intended to use them in making both taxable and exempt supplies but in the event they were used, or intended to be used in making only taxable supplies; and
  * the change of intention occurs within 6 years of the beginning of the period covered by the VAT return in which the original intention was formed.
Pot Pot input tax is another name for residual input tax. The term is also widely used to mean any identified amount of residual input tax.
  So a partial exemption method with only one apportionment calculation is known as a single pot method whereas a sectorised partial exemption method is known as a multi-pot method.
Prescribed accounting period The prescribed accounting period is defined in regulation 99(1)(b) of the VAT Regulations 1995. It is the period allocated to the taxpayer to account for VAT through his VAT return.
  A taxpayer normally submits VAT returns on a quarterly or monthly basis. A taxpayer who is partly exempt must apply their partial exemption method to each prescribed accounting period.
Provisional deduction The provisional deduction is the amount of taxable input tax that the taxpayer can deduct, as determined by the partial exemption method, in the prescribed accounting period. It is adjusted in the longer period.
   

Q

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R

Recoverable percentage / recovery rate The recoverable percentage or recovery rate is the deductible proportion of the residual input tax expressed as a percentage of the total residual input tax.
   
Registration period The registration period is the period of time starting from the effective date of registration and ending on the day before the commencement of the first tax year.
Residual input tax Residual (also known as non-attributable or pot) input tax is the input tax on costs that are used or to be used in making both taxable supplies and exempt supplies and includes any input tax incurred on general overheads.
  In the case of partial exemption methods based on sectors, the residual input tax may be allocated to a number of sectors.
Rounding As it is impracticable to use recovery rates expressed to many decimal points it is normal to round. Rounding in the standard method will be determined by the amount of residual input tax incurred.
  In all other instances, the recoverable percentage must be taken to the nearest two or more decimal places.
   

S

Sector A sector is an area or activity that may be treated separately for partial exemption purposes. It must be clearly defined and able to be supported with VAT accounting information.
   
  A sector might be a geographical location, a product line, a cost or profit centre, a process centre, a development stage, an accounting entity, an investment activity, a customer group, or even a period of time.
  It may also be some combination of these.
Self-supplies Self-supplies are supplies that, under or by virtue of any provision of the VAT Act 1994, the taxpayer makes to himself. Reverse charges under the provisions of VATA 94, s.8 are an example of self-supplies.
Special methods Any partial exemption method that is not the standard method, used to identify the taxable element of input tax incurred. Special methods require the approval of HMRC.
Special method override Where a special method is producing an unfair answer, but it is currently not possible to agree or direct a method that is fair and reasonable, either HMRC or a taxpayer may give notice that the special method override will apply.
  This is set out in regulations 102A to 102C in the VAT Regulations 1995 and states that,
  although the special method calculations must still be made as normal, they will be subject to a use based override on both prescribed accounting period returns and in the longer period adjustment.
Standard method The standard method, as set out in regulation 101 of the VAT Regulations 1995, is the default option over what method a taxpayer must use to calculate their taxable input tax.
Subsequent intervals The capital goods scheme adjusts capital items for changes of use in subsequent intervals. A subsequent interval is a period after the longer period in which the input tax in question was first attributed and will generally be a tax year.
  A capital item passing through a TOGC or a VAT grouping or de-grouping changes how the subsequent intervals will be reckoned thereafter.
   

T

Tax year A taxpayer who is partly exempt has a tax year that is normally dependent on the prescribed accounting period allocated to the taxpayer.
   
  Where the prescribed accounting periods are quarterly, the tax year will be a period of 12 calendar months starting on the first day of April, May or June, depending on the specific prescribed accounting periods allocated to the taxpayer.
  The definition of the ‘tax year’ is set out in regulation 99 of the VAT Regulations 1995.
Taxable input tax Although taxable input tax is not defined in law (unlike exempt input tax which is), a taxpayer who is partly exempt is entitled to deduct any input tax incurred in making taxable supplies and uses a partial exemption method to determining the value of that input tax.
  By implication, taxable input tax is input tax incurred on costs that are used or to be used to make taxable supplies.
  It includes both the input tax that is directly attributable to taxable supplies and the taxable proportion of any residual input tax determined in accordance with the partial exemption method.
Taxable supplies The legal definition of a ‘taxable supply’ is in section 4 of the VAT Act 1994. A taxable supply is a supply of goods and services made in the UK other than an exempt supply.
  Taxable supplies in the UK are not the only supplies that carry the right to deduct associated input tax.
  The term taxable supplies is often (although incorrectly unless specifically agreed) used to include all supplies which carry a right to deduct the input tax on costs which are used or to be used in making them.
  The other supplies carrying the right to deduct are:
  • supplies outside the UK which would be taxable supplies if made in the UK;     
        * certain outside the scope supplies that would be exempt supplies if made in the UK, and exempt supplies made in the UK, that are specified in the Value Added Tax (Input tax) (Specified Supplies) Order 1999; and
        * supplies of investment gold.
      Taxpayer A taxpayer (business) is a taxable person. A taxable person is a person who is, or is required to be, registered for VAT, as defined in section 3(1) of the VAT Act 1994.
         

U

Used or to be used The right to deduct arises in the prescribed accounting period in which the input tax is incurred. A taxpayer is able to exercise that right if the relevant costs are used or to be used to make taxable supplies.
   
  Conversely, the taxpayer is unable to exercise that right if the relevant costs are used or to be used to make exempt supplies. The phrase used or to be used implies that the costs are or will become cost components of the relevant supplies.
  It recognises the fact that a taxpayer can incur input tax on costs, which are to be used immediately, or which are to be used in the future.
   

V

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W

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X

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Y

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Z

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