Partial exemption risks and opportunities

Has your business changed its activities, restructured its operations or experienced staff changes within its finance team? If so, your partial exemption position should be reviewed.

“Businesses that make taxable and exempt supplies fall within the partial exemption rules,” explains Moore Stephens VAT expert Robert Facer. “This means that they won’t normally be able to reclaim all the VAT on their costs, because VAT on costs used in making exempt supplies isn’t normally reclaimable.”

So how do businesses calculate what they can reclaim? “Businesses can use the standard method – a calculation based on the taxable and exempt income of the business,” Robert says. “Any business can use this method, without having to gain HMRC approval. But for many businesses, this may not be the best approach. For example, if a business has exempt income of £2 million and taxable income of £1 million, the standard method assumes that the exempt supplies consume twice as much input VAT as that used in making taxable supplies, which is not necessarily the case. Alternatively, a bespoke ‘special method’ can be used, once approved by HMRC.

Review to reduce risk
Whichever method your business uses, it’s important to keep it under review. “Even if the business itself has not changed, the way that the method is being applied may have done,” Robert says. “For example, ‘method creep’ can arise where, perhaps due to a change in personnel or a past error being repeated, there has been a gradual ‘creep’ away from the original method over time.”

Mistakes can be costly
It’s important that inaccuracies in the method or its application are addressed. “If HMRC discovers that a business has been reclaiming too much VAT, the penalties are likely to be much higher than if the business had identified any issues itself,” Robert warns.

Equally, the business may be entitled to greater VAT recovery than that achieved by the existing method. Where there have been historic under recoveries, a retrospective claim may be possible. Reviewing your method regularly will help to prevent reclaimable VAT being lost.

Whether you require a high level partial exemption healthcheck or a detailed review, our specialist VAT team will be delighted to provide a service tailored to your requirements. To find out more, please contact Robert Facer.

This is the first in a series of four articles on partial exemption issues. Watch out for our next article concerning reverse charge risks.