A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes. This can happen where a business makes or intends to make both taxable and exempt supplies and incurs input tax that relates to both kinds of supply. Under this scenario, the business must make an apportionment between the activities using a 'partial exemption method' to calculate how much input tax is recoverable.
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 distort the calculations. 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 basis as well as completing an annual calculation.