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VAT & Partial Exemption

In business it is important to know what rate of VAT to charge on your sales. The difference between 20%, 5% or no VAT at all will impact margins. Often, sales qualifying as being ‘exempt’ from VAT will bring a cheer to seller and buyer alike. However, this can be deceptive as VAT incurred by the vendor on business costs relating to such exempt sales is not recoverable and becomes a real cost. Purely exempt business will face nil VAT recovery, whilst a business which makes exempt and taxable sales need to address partial exemption.

Partial Exemption!

VAT recovery on costs directly attributable to taxable sales should be straightforward (no recovery for such costs of exempt sales). However for overheads etc. it is not possible to do this and such costs require apportionment based on an approved method.


The standard method for determining recoverable VAT is a percentage derived from the formula:

  • Taxable sales / total sales.

Larger and/or more complex businesses may desire a special method and these can be agreed with HMRC that is based on other formulas such as floor space or headcount. Such special methods can also include agreement on managing more effectively miscellaneous costs (such as those relating to financial investments the business might have), or various pools of costs. Once agreed, it is important to stick to the conditions imposed as any breach can give HMRC an excuse to rescind their agreement.

Methods must produce a ‘fair and reasonable’ result. Quarterly VAT returns are considered provisional; an annual adjustment is required to average VAT recovery for the VAT year. Particular care is needed for larger items such as properties (and related costs) that can fall within the Capital Goods Scheme. More calculations and adjustments can result.

Some good news

For smaller businesses that are partly exempt, there is a de minimis rule, which permits full recovery of VAT on costs if the ‘input’ VAT incurred relating to exempt sales is less than half of total input VAT and is also less than £625 per month on average. Whilst an unwelcome complexity, VAT partial exemption can be an interesting area. Properly managed it can mean increasing the VAT recovery for the business, thus improving the bottom line. The converse is also true. Taking advice on these matters is always recommended as the complexity of the rules can hide some anti-avoidance snares for the unwary.



Date: 22nd October, 2014
Author: Richard Collier


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