Tax rules allow partially exempt businesses to use a “special method” to calculate how much VAT they can reclaim on purchases . How can you create your own special method to reduce your VAT bill?
Are you partially exempt?
A business that makes both exempt and VATable supplies is partially exempt (PE) for VAT purposes. For example, say your company’s main business is selling machine tools (VATable) but it also lets two properties (exempt). The VAT you pay on costs solely relating to the properties can’t be reclaimed, and you can only claim a proportion of the VAT relating to your company’s general costs, i.e. anything not specifically related your VATable or exempt supplies, e.g. office overheads.
How much VAT can you reclaim?
The proportion of VAT you can reclaim on general costs is worked out using HMRC’s standard method unless you ask and HMRC agrees to a special method. The standard method requires you to compare the value of your VATable sales with the exempt sales and limit the VAT you reclaim in proportion to the VATable fraction.
Example. In the quarter ended 31 October 2022 Acom Ltd makes VATable supplies of £200,000 plus exempt supplies of £40,000. It’s entitled to reclaim five-sixths (£200,000/£240,000) of the VAT on general costs.
Tip. Where the amount of VAT paid on costs linked to exempt supplies is small or proportionately small compared to the total, the so-called “de minimis” rule might allow you to reclaim all the VAT on costs even though some of it relates to your exempt supplies.
Special method
The trouble with the standard method is that it doesn’t always result in the greatest amount of VAT reclaimable.
Example 1. In the quarter ended 31 October 2022 Bcom’s VATable sales are £75,000 (retail goods), its exempt income (property rental) is £25,000 and VAT on its general costs is £3,000. Using the standard method Bcom can reclaim £2,250 of this (£3,000 x £75,000/£100,0000). However, all but a negligible part of its general costs relate to its retail sales. This is where a special method can reduce Bcom’s VAT bill.
Tip. A special method can be any calculation that produces a “fair and reasonable” result as long as it’s equally or more fair and reasonable than the standard method. HMRC won’t approve the method otherwise.
Example 2. Bcom, from our example, employs three staff and the firm’s only director. Each works on average 40 hours per week, but only the director spends time managing the properties, typically 10% of his working hours. All the general costs relate to retail shop/office. It would be fair and reasonable to apply a special method that apportions the costs according to the working time spent by the director in managing the properties each quarter (20 hours) compared to the total of his and his staff’s working time (2,080 hours). That would result in Bcom reclaiming 98% of VAT it paid on general costs instead of 75%. Staff time is just one special method that fits Bcom well. There are many others.
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.