Skip to content 
Knowing the rules to keep your finances stable in business taxes is important. The idea of partial exemption comes into play for companies that sell both taxed and exempt goods. When a business has tax costs for taxable and exempt goods, this is called a “partial exemption.” In these situations, getting back the input tax requires a method called “partial exemption,” which requires careful calculations and changes.
The Framework
Sections 24 to 26 of the Value Added Tax Act of 1994 and rules 99 to 110 of the Value Added Tax Rules of 1995 are very important parts of the legal structure for input tax collection and partial exemption. These parts explain what businesses can and can’t do when collecting input tax. They outline the basic rules and principles businesses must follow when sorting out how much input tax recovery they are entitled to and claiming it.
The Value Added Tax Regulations 1995 expand on the Value Added Tax Act 1994. They cover methodologies, formulas, and changes for calculating the recoverable input tax.
Our Specialist Tax Advisors can help you understand the Value-Added Tax Act of 1994 and the Value-Added Tax Regulations of 1995. With our support, companies can ensure they follow the law and make smart choices about their tax-related issues. We can help businesses stay updated on any changes or additions to these laws and follow the most recent rules about input tax collection and partial relief.
Defining Partial Exemption
Let’s look at a few cases to see how input tax recovery and partial exemption work. Goods or services subject to VAT are called “taxable supplies.” One example of a taxed supply is a clothing store in the UK that sells clothes to customers. The VAT that was paid on these sales can be recovered as “input tax.”
On the other hand, things or services that are not subject to VAT are called “exempt supplies.” For example, private schools’ education services and hospitals’ health care services are free goods. Most of the time, you can’t use the VAT you paid on purchases linked to these exempt goods as an input tax.
Now, think about a business that sells both taxed and tax-free goods. Let’s say there is a business that runs a group of grocery stores. They sell taxable things like food and offer exempt products like financial services. Since the company makes taxed and tax-free goods, it is called “partially exempt.”As a partly exempt business, this grocery company has to pay input tax on purchasing inventory, renting store space, and advertising. Some of these costs as the cost of purchasing groceries for sale, are directly related to taxable products. But there are also costs for goods that aren’t taxed, like the fees paid to financial service providers.
The company must make calculations to calculate the percentage of input tax that can be recovered. They have to look at the costs they’ve paid and determine how much of it is related to taxable goods and how much is related to exempt supplies. The input tax directly related to taxable supplies can be fully recovered, but the input tax related to protected supplies is usually not recoverable.
Input Tax Attribution
In the case of limited exemption, knowing how input tax is applied to taxable and exempt goods is important. Let’s look at a few simple examples to show how this idea works.
Example 1: Think about a small shop that sells freshly baked goods. When the bakery buys ingredients, packaging materials, and cooking tools, among other things, it has to pay input tax. Some of these costs are directly related to taxable products as the items used to make the baked goods. The amount of the input tax on these costs can be fully recovered.
But the bakery also has to pay input tax on costs for free goods. Let’s say they have a small place where people can sit and enjoy their goods. Since the bakery doesn’t charge VAT for this extra service, the costs of keeping and furnishing the seating area, such as tables, chairs, and decorations, are free goods. In this case, you can only sometimes get back the input tax you paid on these exempt goods.
Example 2: Imagine a consultancy that offers taxable coaching services and training workshops that are not. The firm pays input tax on office rent, office supplies, and professional software. You can get back all of the input tax directly related to taxable goods, like software used only for consulting services.
But you can only sometimes get back the input tax on costs that relate to exempt goods, like getting a conference room for training workshops. These costs are directly related to the part of the business that is free from tax, so they do not qualify for an input tax refund.
It’s important to remember that under the “de minimis” rules, small amounts of protected input tax may be able to be recovered in some situations. For example, if a business pays only a small input tax on free goods, it may be able to get it back. The de minimis rules set a limit below which businesses can get back tax that they paid but didn’t have to pay. Nonetheless, this threshold is subject to the limitations and conditions outlined in the regulations.
Residual Input Tax and Recovery
Let’s look at a few simple examples to help us better understand residual input tax and the partial exemption calculation:
Example 1: Let’s look at a furniture store that sells both furniture things that are taxed and extras that are not taxed. The retailer has to pay input tax on many things, like buying goods, keeping the store clean, and advertising. Some of these costs as the cost of buying furniture to sell, are directly related to taxed goods. The full amount of the input tax on these costs can be recovered.
But some costs come with goods not subject to VAT, like the expenses related to purchasing accessories. The input tax that goes with these costs can’t be recovered. Now, let’s say the store pays input tax on expenses used for taxable and exempt goods. For example, both types of goods have to pay the rent for the store space or the power bill for the showroom. In this situation, the tax on these costs is called “residual input tax.”
The retailer would have to do a partial exemption calculation to calculate the recoverable percentage of the residual input tax. This calculation gives a fair and acceptable recovery rate when done in the usual way. It helps find how much of the remaining input tax is due to taxable goods so the store can get that amount back.
Example 2: Think about a company that gives both IT services that are taxed and training programmes that are not taxed. When the company buys computer tools, software licences, and office materials, among other things, it has to pay input tax. The input tax on costs directly linked to taxable goods, like computer equipment used to provide IT services, can be recovered in full.
But there are also costs for goods that aren’t taxed, such as the costs of setting up and running training classes. You can’t get back the input tax on these costs. Also, the company has to pay input tax on costs like office rent and energy bills that are used for both taxable and exempt goods. These expenses are known as residual input tax.
Using the standard way of the partial exemption estimate, the company may calculate how much of the residual input tax is due to taxable supplies. This estimate helps find the part that can be recovered, so the company can get the most out of its input tax recovery while following the rules.
Annual Adjustment and Other Considerations
Businesses are required to make a yearly change at the end of a longer time, like a partial exemption tax year. This adjustment is important because it considers any changes that may have happened in the recovery rates of residual input tax over the different tax periods in that longer time. By making this change, companies can ensure that the amount of input tax they get back matches the overall percentages found by the standard method or any approved special method.
For businesses to make accurate estimates and follow the rules, they need to keep thorough and accurate records and accounts. These records should show the input tax paid and the goods made, so businesses can calculate the input tax that can be recovered for each tax period and the whole tax year. Keeping accurate records also promotes transparency and makes it easier for tax officials to do checks or reviews.
It should also be noted that some supplies should be excluded from the conventional technique calculation. These exclusions are needed to avoid calculation distortions. Capital goods (assets) utilized for commercial purposes, regardless of whether they are subject to the Capital Goods Scheme, are included in this category. These capital items, such as machinery or cars, are subject to specific VAT requirements and are dealt with individually.
Furthermore, the standard method calculation should exclude incidental financial or real estate transactions. Most of the time, such transactions come up as a result of regular business activities. They are not the main focus of the business. Two examples are interest on a bank account or the value of a supply that a business makes to itself (called a “self-supply”).
It’s important to remember that transactions not considered supplies for VAT purposes, like the Transfer of a Business as a Going Concern (TOGC), should also be excluded from the standard method calculation. In the same way, a company’s decision to give out new shares to raise money should not be counted.
By excluding these specific supplies, companies can make sure that the standard method calculation shows the correct amount of recoverable input tax for their taxable supplies. This exclusion helps keep the process of calculating accurate and transparent.
Alternative Methods and Flexibility
Even though most businesses use the standard method, they can seek approval to use a different method that fits their needs. Special methods must produce fair and acceptable results and let HMRC verify the calculations. But companies that use a special way ought to be sure it stays reasonable and impartial because HMRC has the authority to demand changes if they think it’s necessary.
We are here if businesses need help handling complicated things like partial exemption and input tax collection. To find the right balance between taxable and free goods and accurately calculate recoverable input tax, you must fully understand the rules and methods involved. Businesses may efficiently manage their input tax recovery, maintain compliance, and optimize their financial operations in a partially exempt environment by becoming familiar with the applicable legislation and receiving suitable guidance.
For VAT compliance, please contact our Specialist VAT Advisors at 0800 135 7323 or email info@taxaccountant.co.uk for expert advice.