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VAT Partial Exemption


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Some topics within VAT are an immediate turn-off! Partial Exemption is one such.

However, for a number of years this has been growing in importance. Basically, most supplies of goods and services are standard rated for VAT. A few are reduced rate or zero rate. However, there are a substantial number of VAT exempt supplies.

They fall into the following categories:

  • Land & Property

  • Insurance

  • Postal services

  • Betting, gaming and lotteries

  • Finance & credit

  • Education

  • Health and welfare

  • Burial and cremation

  • Subscriptions to trade unions, professional and other public interest bodies

  • Sport, sports competitions and physical education

  • Certain sales of works of art

  • Fund-raising events by charities and other qualifying bodies

  • Cultural services

  • Certain supplies of goods where input tax cannot be recovered

  • Investment gold

The effect of making such supplies can be significant in VAT terms. Firstly the income from exempt activities is excluded from the turnover for the purposes of deciding whether a person should be registered for VAT, or deregistered. Secondly, where a person is registered, he cannot reclaim all the VAT input tax incurred by his business. This is called Partial Exemption. And this is where the fun starts! The taxpayer is required to analyse his input tax into three categories: - input tax attributed entirely to vatable activities, which can be claimed in full; - input tax attributed entirely to exempt activities, which cannot be claimed; - other input tax (typically on overheads, but not entirely), of which only some can be reclaimed. It is this third category which can present problems. In the first instance, the analysis of input tax has to be accurate. A computer accounts package may have to be set up carefully to enable this to be done. A manual accounts book may need additional VAT columns.

Example: advertising expenditure can fall into any category.
A motor dealer may include reference to hire purchase finance being available to his customer; an Accountant may include a comment about pensions advice; a large hotel may invite customers to its weekly bingo evening; a newsagent may indicate that it is an agent for the National Lottery. A sports club may advertise a sale of second hand sports equipment.

Essentially, this means that some VAT cannot be reclaimed, which can come as a shock to a business used to claiming all VAT on purchases. Where significant sums fall into the overhead category, then Partial Exemption becomes a significant issue. This will be the case where a large capital expenditure is planned, such as building construction or extension, or redecoration; or a new computer installation, or other necessary equipment. Of course, such expenditure can be carefully planned, to minimise the impact of Partial Exemption. There is also a decision to be made about the method of calculation. The default position is to calculate allowable input tax in proportion to the percentage of vatable sales as compared to all sales. However, this may not always be helpful. VAT Law allows a business to apply to C&E for a Special Method, to better reflect the type of business, and the way in which expenditure is incurred. If this is done carefully, substantial savings can be achieved.

April 2005

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