Your firm is about to complete on the sale of its premises. Because it’s a VAT-exempt transaction will this trigger the tricky partial exemption rules or can this be avoided?
Partial exemption
If in any VAT return period your business makes exempt as well as VATable supplies it is partially exempt. The partial exemption rules block you from reclaiming any VAT on your purchases that relate directly to exempt supplies. The rules reduce the reclaimable VAT on your general purchases, e.g. overheads (referred to as residual VAT).
Standard partial exemption method
The standard method for working out the reduction compares the value of exempt sales to the VATable ones. This means if you make substantial exempt supplies in a VAT period it can result in a significant reduction in the VAT you can reclaim on your general costs incurred within the same period.
Example. Acom makes exempt and VAT sales. Typically, the ratio is 10% to 90% respectively. However, in the final VAT quarter of 2025 Acom makes far more exempt sales than usual, 60%. The VAT on Acom’s general expenses for that period is £1,800. If its sales were 10%/90% it could recover £1,620 (£1,800 x 90%) but because of its unusually high level of exempt sales it can only reclaim £720.
Tip. HMRC’s partial exemption de minimis rules might allow Acom to recover all of the £1,820. It depends on how much VAT it has paid on purchases used to make exempt supplies compared with the proportion of the total VAT incurred by Acom.
Using a special method
In our example we’ve used HMRC’s standard method for working out how much VAT is reclaimable under the partial exemption rules. You can instead use a special method if that produces a better result for you. A special method can be any method that produces a “fair and reasonable” result.
Tip. Some distorting factors are excluded from the partial exemption calculation. For example “real estate transactions”, e.g. purchases or sales of freeholds or leaseholds.
Pros and cons
Excluding certain one-off transactions reduces the risk of you losing out because of the partial exemption calculation. This isn’t largesse on HMRC’s part as the flip-side of the coin is that it prevents a largely exempt business getting a boost in the amount of VAT it can recover on general expenses simply because it sells off a valuable asset on which it has charged VAT.
Fully VATable or exempt businesses
Where a distorting exempt transaction is excluded from your VAT calculations, it has no effect on the amount of VAT you can recover. Therefore, if all your other supplies are VATable you can reclaim the VAT on them in full, subject to the usual limitations and restrictions, e.g. the block on VAT recovery for business entertainment.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.