A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes.
This means that the business is required to make an apportionment between the activities using a ‘partial exemption method’ in order to calculate how much input tax is recoverable.
Businesses that make both taxable and exempt supplies must keep a separate record of exempt supplies along with details of how much VAT has been reclaimed.
There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could prove distortive. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual use of inputs. It is possible to agree a special method with HMRC.
The VAT incurred on exempt supplies can be recovered subject to two parallel de-minimis limits.
The tests are met where the total value of exempt input tax:
- Is under £625 a month (£1,875 a quarter/£7,500 a year); and
- Is less than half of the total input tax incurred.
If both tests are met the VAT can be recovered. Businesses that are partially exempt, need to complete this calculation on a quarterly and annual basis.