Following the first two instalments in our value added tax series of articles we discuss a more technical aspect, being VAT partial exemption.
To understand value added tax partial exemption, you first need to have a broad understanding of the VAT rates,
For the followers of the series you may recall in our first article (https://www.invicta-accounting.com/blog-post/vat-value-added-tax/) we discussed value added tax rates and this is where we first mentioned the Exempt VAT rate.
In short, the Exempt rate applies to certain specific goods and services to which value added tax does not apply. However, this does not mean it does not get included on your VAT return. The sale or purchase amount are still disclosed in box 6/7.
What is VAT partial exemption?
If you consider standard rate value added tax your total taxable supplies are all taxable at 20%, and you can reclaim VAT on purchases in full, simple.
However, you may find that entities make both standard rate and exempt taxable supplies. As discussed in previous articles If you make exempt supplies you cannot reclaim VAT.
To get round this HMRC developed partial exemption which although a little complex at the outset when done a couple of times becomes second nature.
Reclaiming input tax (VAT on purchases)
This is split into 3 stages:
First, you need to attribute any value added tax that is solely related to the standard rate supplies you have made, this can be fully reclaimed
Secondly you should attribute any value added tax that relates only to Exempt supplies and disregard this, as it cannot be reclaimed (BUT it could be subject to de-minimis rules which we will discuss in a moment).
Finally, there will then be items that cannot be directly attributed to either standard rate or exempt supplies and this forms what is known as residual input VAT.
So now we know stage 1 claim it all, stage 2 cannot be claimed (remember de-minimus) and stage three we have a residual amount of which we can claim a percentage.
To calculate the percentage, you must calculate what percentage of total turnover the standard rate supplies constitutes. So, for example you make total supplies of £50,000 and £12,500 is exempt supplies. This means standard rate taxable supplies represents 75% of total supplies. Therefore, we can reclaim 75% of the residual input tax. The other 25% is classed as exempt and not claimable (you guessed it……. subject to de-minimus rules)
See HMRC guidance on taxable supplies to get an idea of how a company can become partially exempt based on activities undergone https://www.gov.uk/guidance/rates-of-vat-on-different-goods-and-services
The De-minimus rule
If the exempt supplies referred to previously being the wholly attributable and the residual VAT are below the de-minimus then all input tax can be claimed.
To apply the de-minimus two conditions need to be met:
- Input VAT attributed to exempt supplies (both directly and residual) must not exceed £1,875 per quarter.
- Input VAT attributed to exempt supplies must not be more than 50% of the total input VAT in the quarter.
Effectively this allows companies making small amounts of exempt suppliers to still recover some if not all the input VAT which otherwise they wouldn’t.
With value added tax partial exemption the final piece of the puzzle is the annual adjustment. Basically, you complete your VAT returns as normal and then at the year end (March/April/May)
To surmise you add all your returns up and calculate everything over the year. You then check if the de-minimus has been breached.
If the de-minimus has been breached, then the appropriate input tax is then paid to HMRC.
However, the flip side is that over the year you may end up below the de-minimus and therefore you can reclaim all the Input VAT.
The annual adjustment is designed to allow for timing differences that occur, some quarters you may breach de-minimus whereas others you won’t, it effectively averages everything out for the year.
How can Invicta help?
Invicta has staff experienced in value added tax partial exemption and people who know the system inside out. Calculations to us are routine.
We can take over the administration, split the input tax appropriately and calculate the de-minimus and then the annual adjustment and you won’t have to even think about percentages and exempt supplies! Let us take the strain, we thrive on it!
Call Invicta Accounting on 01624 672358 or emails us at firstname.lastname@example.org to discuss your requirement.
Visit our website for more information on our other blog articles and keep your eyes peeled for the next installment in our value added tax series https://www.invicta-accounting.com/blog-post/