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Simplifying partial exemption

20/04/2017

For years there was only one, potentially fiddly, method to work out the amount of VAT reclaimable where partial exemption applies. However, two alternative tests could make your life easier. How do they work?

Partial exemption changes

The world of tax doesn’t stand still for long, yet the rules for VAT partially-exempt businesses, i.e. those which make both VATable and exempt sales, had been unchanged for years until April 2009 when a number of simplifications were introduced. Just a year later further changes were made, and they included something which might make a real difference to the amount of VAT your business can reclaim.

De minimis rule

Where purchases of goods or services are used to make only exempt sales, you can’t reclaim VAT paid on the cost of these. But where your company also makes VATable supplies, this opens the door to reclaiming some VAT. Better yet, where two conditions are met you can reclaim not just some but all the VAT you’ve paid, whether it’s linked to exempt supplies or not. This is the so-called de minimis rule. The conditions are that:

• the total VAT you’ve paid out on “purchases which are used to make exempt supplies” isn’t more than £625 per month on average; and
• it’s not more than 50% of the VAT you paid on all your purchases.

Simplified de minimis rule

Since April 2010 there have been two alternative de minimis tests. At first glance they look similar but on closer reading you’ll see that they are both different to the existing de minimis test.

First test

All VAT on purchases can be reclaimed where:

• the total VAT on “all” purchases isn’t greater than £625 per month on average; and
• the value of exempt supplies you make is not greater than 50% of the total supplies you make.

Second test

All VAT on purchases can be reclaimed where:

• the total VAT on all purchases, less the VAT on purchases used to make VATable supplies, is no greater than £625 per month on average; and
• the value of your exempt supplies is no more than 50% of your total supplies.

Tip 1. You can apply the de minimis rules retrospectively. This means that if you’ve used one rule during the year to check whether your business met the de minimis conditions, and it failed, you can go back at the end of the year and check if it will pass using one of the alternative methods. You can then make an “annual adjustment” and reclaim any extra VAT you’re entitled to.

Tip 2. Where your business qualifies as de minimis in one year, meaning you can reclaim VAT on all purchases, you can assume this is the case for the following year. But you must review the position after the year end and if it doesn’t meet one of the three tests, the VAT must be repaid.