Introduction
Tax agents and advisers play an important role in helping their clients to get their tax returns correct.
This toolkit is aimed at helping and supporting tax agents and advisers in completing VAT Returns on behalf of their clients, although it may also be of use to anyone who is completing a VAT Return. It may also be of use to tax agents and advisers who do not
complete their client’s VAT Return but wish to use it as a source of reference when advising their client on VAT matters or for reviewing their client’s VAT declarations at the year end.
This version of the toolkit was published in July 2016. The risks in this toolkit have been reviewed and updated where
necessary. Its use is entirely voluntary.
The content of this toolkit is based on our view of how tax law should be applied. Its application to
specific cases will depend on the law at the relevant time and on the precise facts.
This toolkit is not a comprehensive statement of all input tax risks that may arise nor does it provide
for all circumstances that a business may encounter. Areas of input tax that it does not address include:
·
second-hand schemes - see
VAT margin schemes for second-hand goods, art, antiques
etc
·
the Tour Operators Margin Scheme - see
Public
Notice 709/5 Tour Operators Margin
Scheme
·
agency arrangements - see section 22 (Supplies made through or by agents: general rules) of
Public Notice 700 The
VAT Guide
·
pension schemes - see
Public
Notice 700/17 Funded pension schemes
This toolkit includes information on the following:
·
preventing the application of the Lennartz approach to purchases of land, buildings, aircraft, ships, boats and other vessels made on
or after 1 January 2011
·
extending the Capital Goods Scheme (CGS) to certain purchases of aircraft, ships, boats and other vessels made on or after 1 January
2011
·
extending the CGS to require input tax adjustments to reflect changes in the level of non-business use, including private use, of assets
purchased on or after 1 January 2011
·
a number of technical changes in the operation of the CGS
·
extending the requirement to make 'payback' and 'clawback’ adjustments when input tax is claimed or restricted on the basis of intended
levels of business use, and that intention changes before use occurs
·
the treatment of input tax incurred in the course of entertaining overseas customers
·
the introduction of formalised special methods to apportion VAT incurred for business and non-business purposes and, where businesses
are required to carry out partial exemption calculations, special methods incorporating both business/non-business and partial exemption calculations
For further information on using this toolkit and reasonable care under our penalty system see
Tax Agents Toolkits
For guidance on matters not dealt with in this toolkit you should refer to our full guidance:
VAT Input Tax (VIT)
Reclaiming VAT on purchases made before registration or after deregistration
A business may generally reclaim some, or all, of the VAT incurred on goods it has purchased no more than
four years before the date of registration. The goods must, however, be for its taxable business purposes and remain on hand at the date of registration. A business may also generally reclaim VAT incurred on services it has purchased for its taxable business
purposes during the six months before VAT registration. VAT cannot be claimed on goods and services purchased before registration which are used to make exempt supplies or for non-business activities.
For further information and details of record-keeping requirements see
Purchases made
before VAT registration: reclaiming the VAT.
Once a VAT registration has been cancelled there are limited circumstances in which input tax can still
be claimed. Input tax can be claimed on goods and services supplied to the business while it was registered for VAT. It can also be claimed on services (such as legal or accountancy advice) which relate solely to the activities of the business while it was
VAT registered. VAT cannot be claimed on goods purchased after deregistration.
For more information see
Reclaiming VAT after you cancel your registration.
Flat Rate Scheme
A business using the Flat Rate Scheme (FRS) should not generally claim input tax on its VAT Returns. Input
tax may however be claimed on individual purchases of capital expenditure goods with a VAT inclusive cost of £2,000 or more. Input tax cannot be claimed on goods purchased for resale or to be leased, let or hired. Input tax cannot be claimed on expenditure
which relates to work performed on a capital item, for example the refurbishment or extension of premises. A business which has newly registered for VAT may also claim VAT on stock and assets on hand at the time of registration subject to the normal rules
for such claims. If a business using the FRS is required to account for acquisition tax on the purchase of goods from a supplier elsewhere in the European Union (EU) this cannot be claimed as input tax unless it relates to the purchase of capital expenditure
goods costing £2,000 or more including the related VAT.
For more information see
Flat Rate Scheme for VAT.
Areas of risk within VAT input tax
The main areas of risk within VAT input tax broadly fall into the following categories:
Record keeping
Good record keeping is essential, as poorly kept records can mean that the VAT Return is prepared on the
basis of inaccurate or incomplete information. Where a business operates from more than one location it is also important that procedures are in place to ensure that all relevant accounting information needed for completing the return is reported to the person
that prepares it in time for inclusion on the return.
For further information on record keeping see
Record keeping fact sheet.
Even when records are well kept, mistakes, duplications and omissions may occur, resulting in input tax being claimed too early, too late or in the incorrect amount. If a computer
package is used to calculate VAT Return values, care should be taken to ensure that correct date ranges are set and that all relevant transactions within the period date range are included.
The requirement to add back input tax if the related expenditure remains unpaid six months after the date of the supply or the due date for payment (whichever
is the later) is also often overlooked.
Private and non-business use
In many businesses personal and business finances can be closely linked and input tax may be claimed incorrectly
on expenditure which is partly or wholly for private or non-business purposes. ‘Business purpose’ can be a complex area in relation to input tax.
For further guidance see
VAT Input Tax VIT10200,
VIT10400,
VIT10600
and
VAT
Business/Non-Business (VBNB).
When expenditure has a mixed business and private/non-business purpose the related VAT should generally
be apportioned and only the business element claimed. Under the Lennartz approach when a business purchases an asset, or services resulting in the construction of a new asset, which has mixed business and private use (but generally not mixed business and non-business
use other than private use), the VAT may be claimed in full at the time of purchase but output tax must subsequently be declared to reflect private use. From 1 January 2011 the Lennartz approach cannot be adopted for purchases of land, buildings, aircraft,
ships, boats and other vessels - see Q8.
When goods on which a business has claimed input tax in full (such as an item of stock) are subsequently
put to private or non-business use, there is generally a deemed supply for VAT purposes and output tax is normally due on the cost of the supply. The deemed supply is one of goods if the change of use is permanent and of services if temporary. There are, however,
separate rules for land, buildings, civil engineering works, computers, aircraft, boats and other vessels which are purchased on or after 1 January 2011 and are subject to the
Capital Goods
Scheme.
For
more information see
Notice 706/2 Capital Goods Scheme.
Partial exemption
When a business has expenditure which relates wholly or partly to existing or intended exempt supplies,
as well as taxable supplies, it becomes partly exempt and can only claim the related input tax if it is below the prescribed de minimis limit. For a list of exempt supplies which are commonly made see
Q9. The partial exemption standard
method determines how much input tax can be claimed unless an individual special method has been approved by HMRC. Many businesses do not recognise that they are partly exempt or carry out partial exemption calculations incorrectly, for example by using an
unapproved special method or by omitting to carry out a longer period calculation.
If certain assets (computers or land/building works over specified values) have been purchased for use
in the business, those assets are subject to adjustments under the CGS to reflect changes in the degree of taxable use relative to exempt use. The need to consider CGS adjustments is often overlooked.
From 1 January 2011 the CGS has been extended to include purchases of aircraft, ships, boats and other vessels over a specified value. For any items subject to the CGS where the
input tax is incurred on or after 1 January 2011, the CGS adjustment must also include any change in the level of non-business or private use.
Business entertainment
Input tax is often claimed in error on the provision of business entertainment. This includes, for example,
the provision of hospitality or entrance to theatres, concerts and sporting events, and similar expenditure. Input tax cannot be claimed on business entertainment provided to anyone other than employees or overseas customers. While input tax may be recovered
on the business entertainment of overseas customers, in many cases an equivalent output tax charge will arise.
Entertainment costs allocated to expense headings such as advertising or marketing are often overlooked
and the related VAT claimed in error.
Cars and motoring expenses
Input tax errors frequently occur in relation to the purchase or lease of cars and to motoring expenses
in general. Input tax cannot be claimed on the purchase of most cars while the recovery of VAT incurred in leasing a car which is available for private use should be restricted to 50%. If a business supplies fuel for cars and claims the input tax, an output
tax scale charge is generally due for each car to account for any non-business use, unless records are maintained to demonstrate that fuel has only been provided for business journeys. Input tax claimed in respect of business mileage payments must be restricted
to the fuel element of the mileage rate and be supported by original fuel purchase invoices.
International transactions
There are distinct mechanisms for the payment and recovery of VAT on goods purchased from suppliers outside
the EU (imports) and inside the EU (acquisitions). If these are not applied correctly input tax error can result.
The purchase of many services from overseas suppliers requires the UK recipient to account for both output
tax and input tax on the supply (the reverse charge), applying any appropriate restrictions to input tax recovery - this requirement is often overlooked or incorrectly performed.
Using links within the document
Blue underlined text
are links within this document.
Green bold text
are hyperlinks to external documents on the internet (access to the internet is
necessary to view these).
We have a range of services for people with disabilities, including guidance in Braille, audio and large
print. Most of our forms are also available in large print. Please contact any of our helplines if you need these services.
Dealing with HMRC if you have additional
needs
Giving HMRC feedback on toolkits
HMRC would like to hear about your experience of using the toolkits to help develop and prioritise future changes and improvements. HMRC is also interested in your views of any
recent interactions you may have had with the department.
Send HMRC your feedback
Client Name:
Period Ended:
Checklist for VAT input tax
Record keeping
Yes
No
N/A
Partial exemption
Yes
No
N/A
9
Have
partial exemption
calculations been carried out correctly if required?
Capital Goods Scheme
10
Have
Capital Goods Scheme
adjustments been carried out correctly if required?
Business entertainment
11
Has the recovery of input tax on
business entertainment
been restricted?
Cars and motoring expenses
12
If a
car
has been purchased has input tax recovery been restricted appropriately?
13
Has input tax been restricted on the
lease or long-term rental
of cars available for private use?
14
Has input tax been claimed correctly on the purchase of
fuel for cars?
15
Has input tax been correctly adjusted in respect of
vehicles other than
cars
which
are available for private or non-business use?
16
Has input tax been claimed correctly on
business mileage
payments to employees?
International transactions
Yes
No
N/A
Explanation and mitigation of risks
Record keeping
1. Have input tax records been reviewed for posting errors?
Risk
Many input tax errors are the result of misposting or misunderstanding when transactions are first entered
in the records. See explanation
below for a list of common errors.
Mitigation
A general review of input tax postings prior to submission of the VAT Return will often identify and eliminate many common
errors.
Comparing the tax and net summary totals may also highlight any significant mispostings. Compare the
calculated input tax to the amount claimed on the last return or on the return for the same period last year and consider whether any significant variations are consistent with your understanding of the business and its development.
Explanation
Common errors include:
·
duplicated claims - particularly where requests for payment or pro-forma invoices have been received
·
manual, arithmetical and consolidation errors
·
input tax incorrectly calculated on VAT inclusive amounts
·
VAT and net values transposed
·
input tax incorrectly calculated for VAT reduced-rate purchases or transactions subject to a settlement discount
·
input tax claimed on purchases which do not carry VAT (such as stamps, train/air/bus tickets, some tolls)
·
input tax claimed on costs incurred outside the UK (for example conference/business trip accommodation and meals) -
see below
·
Insurance Premium Tax (IPT) claimed as input tax
·
VAT Return and assessment payments claimed as input tax
·
purchase credit notes incorrectly posted
·
self-billed sales invoices on which output tax is due posted as purchase invoices
·
input tax claimed on costs proper to a third party - for further information see
Supply and
consideration VATSC90000
Some computer accounting packages have integral VAT audit functions which can assist in identifying potential errors before
a return is submitted.
While VAT incurred in other European Union (EU) states cannot be claimed as input tax, it may be recoverable from the relevant
national authority.
For further information see
VAT refunds for UK businesses buying from other EU
countries
back to checklist
2. Is satisfactory evidence held to support input tax claims?
Risk
Input tax claims must normally be supported by VAT invoices. If VAT invoices are not obtained, input tax may be claimed incorrectly in respect of purchases from unregistered suppliers
or for supplies which do not carry VAT. Purchases from new or infrequent suppliers are more likely to be unsatisfactorily evidenced.
Mitigation
Ensure input tax claims are supported by VAT invoices or less detailed or modified VAT invoices. For
information on VAT invoices see explanation
below.
Where input tax is claimed on the payment made against a supplier’s statement, the supporting invoices should be reconciled
to the statement.
When a supplier has issued a pro-forma invoice or a request for payment, check that a VAT invoice has subsequently been
obtained to support the input tax claimed.
Explanation
A VAT invoice must be issued when a registered person makes a standard or reduced-rated supply to another
registered person. In the case of retail sales the supplier may issue a less detailed VAT invoice (if the value of the individual supply is less than £250) or a modified VAT invoice.
For further information on VAT invoices see
VAT record keeping.
Exceptions to the requirement for a VAT invoice in the business’s name are:
·
invoices issued to employees for road fuel, subsistence, small tools and site costs purchased for business purposes (although alternative
evidence - such as the employee's invoice and proof of reimbursement by the business - should be retained)
·
telephone calls made from public or private telephones, purchases through coin-operated machines, car park charges (not on-street meters
which are not subject to VAT), some commercial tolls, where the expenditure on each item is £25 or less including VAT
For further guidance see
VAT Input Tax VIT31200.
back to checklist
3. Have the records been reviewed to ensure that input tax has been claimed at the correct
time?
Risk
Input tax should normally be claimed on the VAT Return relevant to the tax point (time of supply) shown
on the supplier’s invoice. In certain circumstances input tax may be claimed on a later return, for example when awaiting the invoice from a supplier, but input tax must not be claimed on an earlier return. Timing errors often occur in respect of high value
purchases made shortly after the end of a tax period or when goods are purchased on hire or lease purchase terms.
Mitigation
Ensure input tax is claimed correctly against the tax point on the supporting VAT invoice. In particular,
consider expenditure towards the end of the tax period and ensure that input tax is claimed at the correct time. Where goods have been purchased on hire purchase or lease purchase, check that the correct tax point is used by reference to the relevant finance
agreement.
Explanation
Input tax must be claimed on a VAT Return within four years of the due date for the return period in which the supplier’s
tax point falls.
If the Cash Accounting Scheme is being used, the point at which input tax may be claimed is the date of
payment.
When purchase invoices and credit notes proper to an earlier VAT Return period are posted late to a computerised
accounting system care needs to be taken to ensure that all relevant transactions are included. A reconciliation of the calculated VAT Return values to the nominal ledger VAT control or input tax control account should highlight such omissions.
When a business reclaims input tax following a change in the tax rate, it must claim it at the rate charged
by the supplier.
For further guidance see
VAT Input Tax VIT30000.
back to checklist
4. Has input tax claimed on expenditure which remains unpaid after six months been added
back?
Risk
Input tax claimed on expenditure which remains unpaid six months after the relevant date must be repaid.
The relevant date is the date of the supply or, if later, the due date for payment.
Mitigation
Review aged creditors listing and purchase ledger accounts for any unpaid expenditure over six months old
upon which input tax has been previously claimed. Ensure input tax is added back appropriately. If the invoice is subsequently paid input tax can then be claimed.
For further guidance see
Notice
700/18 Relief from VAT on bad debts.
back to checklist
Private and non-business use
5. Has input tax been restricted appropriately on expenditure for private purposes?
Risk
For many businesses private and business finances can be closely linked. While a business may pay a range
of bills and expenses for the private purposes of its directors, proprietors and partners, the related VAT cannot be claimed. For common types of private expenditure see
explanation
below.
Such expenditure may not be identified, for example on expense claims, and
the related VAT claimed in error.
Mitigation
Review input tax records, including expense claims, for private expenditure and ensure that the related
VAT is not claimed.
There are separate rules for motoring expenses - see
Q12-Q16
below.
For expenditure with a mixed purpose see
Q7
below.
For further guidance see
VAT Input Tax VIT10200.
Explanation
Common examples of private expenditure include:
·
domestic accommodation, household bills such as repairs and maintenance, groceries, furniture, domestic heat, light and telephone,
pets - although if such expenses have an element of business use an apportionment may be appropriate - see
Q7
·
personal clothing (other than uniforms or necessary protective clothing)
·
private hotel stays and taxi trips
·
hobbies, sports and leisure activities
·
legal and taxation advice which is not for the purposes of the business - for more information on taxation advice see
VAT Input Tax VIT13600
and
VIT13700
·
meals and drinks (other than meals taken for business purposes when away from the normal place of work - excluding business entertainment)
back to checklist
6. Has input tax been restricted appropriately in respect of non-business, other than
private, activities?
Risk
Most commercial activities clearly represent ’business’ for VAT purposes and the VAT incurred on related
expenditure can be reclaimed subject to the partial exemption rules and specified exclusions. Other activities, particularly in the grant funded and voluntary sectors, do not constitute ’business’ for VAT purposes and the VAT on related costs cannot be claimed.
Most hobby activities are not ’business’ for VAT purposes even though low value and/or infrequent supplies may be made.
Mitigation
Consider the full range of activities undertaken to identify any which are non-business. Review input
tax records to identify non-business activities and eliminate incorrect input tax claims.
Explanation
If a service is provided free of charge or is funded largely by grants or donations, it may not constitute
a business activity for VAT purposes. A business may have a range of activities each of which must be considered individually. For example a charity may have both business activities (such as the sale of donated goods) and non-business activities (such as
the provision of free of charge welfare support and advice).
VAT incurred on expenditure which relates wholly to a non-business activity cannot be claimed. VAT on expenditure with mixed business and non-business use should be apportioned
and the business element only claimed - see Q7
below.
For further guidance on deciding whether an activity constitutes business for VAT purposes see
VAT Business/Non-Business (VBNB).
There are special rules for Local Authorities and similar bodies. For further information see
Public
Notice 749 Local Authorities and similar bodies.
For further guidance see
VAT Input Tax VIT20000.
back to checklist
7. Has VAT incurred on expenditure with mixed business and private/non-business
use been correctly adjusted?
Risk
Unless the Lennartz approach is adopted (under which input tax on certain expenditure is recovered in
full at the time of purchase and output tax adjustments are made subsequently to reflect private use - see
Q8) VAT incurred on expenditure
which has mixed business and private/non-business use should be apportioned appropriately and only the business element claimed.
Mitigation
Review input tax records for expenditure with mixed business and private and/or non-business use. If
the Lennartz approach is not adopted, establish the extent of actual or intended business use and ensure only the business or intended business element is claimed.
For ongoing costs (such as heating/ lighting/telephone) the basis of apportionment should be reviewed
to ensure that the apportionment remains fair and reasonable.
Explanation
The law does not specify a method of apportionment for costs incurred with mixed business and private
and/or non-business use - the only requirement is that the result is fair and reasonable.
From 1 January 2011 HMRC can approve a business/non-business method of apportionment, not including
private use, when requested by the business. For more information see section 7
of
Notice 706 Partial Exemption.
If the Lennartz approach is not adopted or not available, an apportionment should be made on the basis
of use or intended use. An apportionment can be based on factors such as:
·
income streams
·
use
·
employee time
·
floor space within a building
Any apportionment method employed for ongoing costs should be reviewed regularly to ensure that it continues
to produce a fair result. A record should be kept of how the basis for apportionment has been established.
When acquiring an asset for mixed business and private/non-business purposes a business may make a choice to exclude all or part of that
asset from the business’s assets, by holding it privately or as a non-business asset. For more information about the VAT treatment of an asset or part of an asset excluded from the business’s assets see
Public Notice
706/2 Capital
Goods
Scheme.
When goods on which a business has claimed input tax are subsequently put to private use, there may
be a deemed supply for VAT purposes and output tax is due on the cost of the supply. Where goods are transferred out of the business so they are no longer treated as business assets there is a supply of goods.
For further information see
Private use of goods or services, self-supply and VAT.
For further guidance see
VAT Input Tax VIT20000.
For capital expenditure on land, buildings, civil engineering works, computers, aircraft, boats and
other vessels made on or after 1 January 2011 an adjustment mechanism to take into account changes in use of these assets has been introduced by adapting the Capital Goods Scheme to include changes in private/non-business use (see
Q10).
Additionally, from 1 January 2011 when input tax is claimed or restricted on the basis of intended business, non-business
or private use and that intention changes before actual use occurs, the original input tax treatment must be revisited and adjusted. Such adjustments are known as 'clawback' and 'payback'. For more information see Q12 of the
VAT Partial
Exemption
Toolkit.
back to checklist
8. Have Lennartz output tax adjustments been made if required?
Risk
Under the Lennartz approach, when a business incurs VAT on the purchase of an asset, or on services resulting
in the construction of a new asset, which has mixed business and private use, input tax is recovered in full at the time of purchase. However, output tax adjustments are required over the life of the asset to reflect the full cost of any private use.
For the purposes of a Lennartz calculation the life of an asset is ten years for land and buildings purchased before 1
January 2011 and five years for other assets.
With effect from 1 January 2011 the Lennartz approach is not available for purchases of land, buildings,
aircraft, ships, boats and other vessels.
Mitigation
Ensure that the Lennartz approach is not adopted in respect of ineligible items. Identify any assets
on which Lennartz output tax calculations are required. Ensure the necessary output tax adjustments are made, keeping a record of their calculation.
Explanation
If VAT is incurred on the purchase of an asset, or on services which result in the construction of a
new asset, and the asset is used for mixed business and private purposes, the Lennartz approach may be adopted and input tax recovered in full at the time of purchase. However output tax reflecting the full cost of the private use must be declared over the
life of the asset.
The full cost of private use is determined with reference to the taxable VAT -bearing costs of the asset
(excluding VAT) spread over the specified economic life. There is no prescribed method for determining the extent to which goods are put to private use but whichever method is used must be fair and reasonable and demonstrably reflect actual levels of use.
The level of private use may change and must be monitored from period to period over the asset’s specified economic life.
A decision to adopt the Lennartz approach must be made at the time of purchase and cannot be revisited
at a later date. Eligibility to use the Lennartz approach is subject to certain conditions.
With effect from 22 January 2010 use of the Lennartz approach was restricted to goods and services having mixed business and private use. Since that date the Lennartz approach
has generally no longer been available for assets having mixed business and non-business use.
Businesses which have adopted the Lennartz approach in respect of non-business use other than private
use prior to this change may choose one of two options:
·
to continue to make Lennartz output tax adjustments over the specified economic life of the asset
·
to unravel the whole Lennartz calculation and adjust both input tax and output tax
For further information see
VAT Input Tax VIT25510,
VIT25540
and
VIT25550.
From 1 January 2011 the Lennartz approach is not available for the purchase of
land, buildings, aircraft, boats and other vessels having mixed business and private use. Any VAT incurred on such assets must be apportioned to reflect the level of business use (see
Q7) and if these are capital
items adjustments must be made over the economic life of the asset under the Capital
Goods Scheme (see
Q10
). Where the Lennartz approach has been adopted in respect of such assets purchased
before 1 January 2011, the business must continue to use that approach in respect of that asset. Any VAT incurred on or after this date is recoverable only to the extent that the asset is used to make taxable supplies.
For further information see
VAT Input Tax VIT25510.
back to checklist
Partial exemption
9. Have partial exemption calculations been carried out if required?
Risk
A business may not recognise that it is partly exempt. For example many businesses whose core business
activity is taxable may also receive exempt property income or commissions (insurance/finance/lottery) making them partly exempt. When exempt supplies are made or intended, the business is partly exempt and the recovery of related input tax may need to be
restricted.
Mitigation
Review the activities of the business, including those which are secondary or incidental, to identify
existing or intended exempt supplies. It is important to differentiate between exempt supplies and zero-rated supplies (which carry no VAT but are taxable).
Input tax incurred in relation to exempt supplies may only be claimed if it is below de minimis levels
- see explanation
below. The partial exemption calculation specifies how exempt input tax must be quantified and how much input tax may be claimed.
Any required adjustments for private or non -business use must normally be carried out before the partial
exemption calculation. However, with effect from 1 January 2011 a business may apply for a special method (known as a 'combined method') which combines its business/ non-business calculation (other than any adjustments for private use) with its partial exemption
calculation.
Ensure that partial exemption calculations are carried out in accordance with the standard method or an
approved special method. Confirm that a longer period adjustment is carried out at the appropriate time.
For further guidance on the standard method, longer period adjustments and other issues see
Partial exemption PE10000-PE80000
and
Public Notice 706
Partial exemption.
Section 4 of Public Notice 706 includes a worked example of a standard method calculation.
Explanation
Exempt supplies are set out in Schedule 9 to the VAT Act 1994 and include:
·
many land transactions (including rents) - but generally not when an option to tax has been exercised in respect of the property in
question - see Public
Notice 742 Land and property
·
insurance
·
betting, gaming and lotteries
·
finance
·
education
·
health and welfare
·
some sports activities - see
Public Notice 701/45 Sport
·
some charity fund-raising events - see
How VAT applies to fundraising events
·
cultural services subscriptions to some membership organisations - see
Public Notice
701/5
Clubs
and Associations
The basis for apportioning non-attributable input tax between exempt and taxable supplies is specified
in the partial exemption standard method which must be followed unless a partial exemption special method has been approved.
Exempt input tax is the total VAT incurred on expenditure to be used exclusively in making exempt supplies
plus a proportion of VAT incurred on costs which cannot be wholly attributed to either taxable or exempt supplies (including general overheads). Input tax incurred in relation to the making of exempt supplies may only be claimed if it is below a de minimis
limit (not more than £625 per month on average during the period or longer period, normally the tax year, and not more than 50 per cent of total input tax in the relevant period). Simplified de minimis tests for smaller businesses have been introduced from
1 April 2010 - see Public
Notice 706 Partial
exemption.
If
the use of a 'combined method' is approved, the normal de minimis limit does not
apply and no exempt input tax can be claimed.
back to checklist
10. Have Capital Goods Scheme adjustments been carried out if required?
Risk
For most goods and services the proportion of VAT that may be claimed is determined at the time of
purchase and confirmed by the relevant longer period partial exemption calculation. However, certain land and computer assets are subject to the Capital Goods Scheme (CGS) and the extent of taxable use must be monitored over a specified period. With effect
from 1
January 2011 the CGS has been extended to include capital expenditure on aircraft, boats and other vessels with a VAT-exclusive
cost of £50,000 or more.
An input tax adjustment may be required to reflect any changes in the extent of taxable use or the liability of any disposal during that adjustment period. For assets subject to
the CGS where the capital expenditure was incurred on or after 1 January 2011, adjustments are also required to reflect changes in the extent of business and non-business/private use.
Mitigation
Identify assets which are subject to CGS adjustments. Ensure appropriate CGS adjustments are made.
Explanation
Assets subject to the CGS are referred to as 'capital items'. Only items used as capital assets of the
business are subject to the CGS - items for resale are excluded.
The CGS applies to capital expenditure on land, buildings, civil engineering works
and refurbishments where the VAT exclusive standard or reduced-rated costs are £250,000 or more. It also applies to any computer with a VAT exclusive cost of £50,000 or
more. 'Computer'
means a single item of equipment rather than a complete network - computer software and computerised equipment are not included.
With effect from 1 January 2011 the CGS has been extended to apply to capital expenditure on aircraft,
ships, boats and other vessels with a VAT exclusive cost of £50,000 or more. As well as
VAT incurred in the purchase of such items, the CGS also includes VAT incurred in the course of their manufacture, refurbishment,
fitting out or alteration.
Prior to 1 January 2011, only VAT on business-related expenditure (that is input tax) fell within the CGS.
With effect from 1 January 2011, all of the VAT on an asset (that is input tax and non-business, including private, VAT) falls within the CGS.
The period over which CGS adjustments are required is called the 'adjustment period'. This is split into a number of intervals (normally years)
which are aligned with the business's partial exemption year. The adjustment period for land, buildings and civil engineering works is normally ten intervals, while for other CGS items it is normally five intervals. With effect from 1 January 2011, however,
the number of intervals may vary if the business's interest in an asset is more than one year less than the standard CGS adjustment period. For more information see
Public
Notice 706/2 Capital Goods Scheme.
A business does not have to be partly exempt or have non -business activities when it acquires an asset for the CGS to apply. For example a fully taxable business may be required
to make a CGS adjustment if a CGS building used for wholly taxable purposes is the subject of an exempt sale or lease during the specified adjustment period.
For more information see
VAT Partial Exemption Toolkit.
back to checklist
Business entertainment
11. Has the recovery of input tax on business entertainment been restricted?
Risk
Input tax cannot be claimed on the provision of entertainment to anyone other than an employee or an
overseas customer. The provision of food and drink, theatre or concert tickets, accommodation, entry to sporting events and facilities, or the use of capital assets such as yachts and aircraft for the purpose of entertaining, are all classed as business entertainment
for
VAT purposes.
Sponsorship arrangements can also include elements of business entertainment and apportionment of the
input tax may be required.
Where input tax is incurred in relation to the entertainment of an overseas customer it may be claimed
but an equivalent output tax charge may arise. There are two tests that should be considered to establish whether a charge to output tax arises - the necessity test and the strict business purpose test - for more information on business entertainment and overseas
customers see Revenue
& Customs Brief 44/10.
Mitigation
Identify all entertainment costs and ensure input tax is not recovered or is apportioned appropriately.
Consider analysing headings such as marketing or advertising which may include business entertainment. If input tax is claimed on the business entertainment of overseas customers, consider whether an equivalent output tax charge arises.
Explanation
The recovery of input tax on the provision of entertainment for employees is generally allowed. For
entertainment purposes employees include directors and partners but not former employees, job applicants and shareholders. However, when entertainment is provided solely for directors or partners of a business, the expenditure is not for business purposes
and the related VAT cannot be claimed. ‘Perks’ which are provided to specific individuals within a business are generally subject to an output tax charge.
When an employee, director, proprietor or partner acts as host to non-employees, the business entertainment
rules apply and the related VAT should not be claimed. If employees and non-employees are entertained (for example at a Christmas party attended by employees and employees’ guests) the VAT should be apportioned and only the proportion relating to staff entertainment
claimed.
VAT incurred on actual subsistence costs reimbursed to employees, and to subcontractors treated as employees,
may be claimed if incurred for business purposes. Input tax cannot be claimed on flat rate subsistence allowances.
For further guidance see
VAT Input Tax VIT40000
and
Public
Notice 700/65 Business
entertainment.
back to checklist
Cars and motoring expenses
12. If a car has been purchased has input tax recovery been restricted appropriately?
Risk
Input tax can only be claimed on the purchase of a car when one of the following applies:
·
it is a stock in trade car of a manufacturer or a dealer
·
it is intended to be used primarily as a taxi, a driving instruction car or for self-drive hire
·
it is to be used exclusively for business purposes and will not be available for anyone’s private use, which normally includes home
to work journeys
This restriction applies to purchases of new cars and of second-hand cars on which VAT has been charged.
Input tax may be claimed on the purchase of a pool car that is kept at business premises, used only for
business journeys and not taken home overnight by employees. In a limited range of circumstances input tax may be claimed on a pool car taken home overnight where to do so is necessary for the purposes of the business.
If a car on which input tax has been claimed is subsequently put to a different use which would not permit
input tax recovery (for example a pool car is made available for private use), a 'self supply' occurs and output tax must be declared on the current value of the car at the time of change of use.
For more guidance on availability for private use see
VAT Input Tax VIT52700
and
VIT54800
Mitigation
Identify any cars purchased in the period. Ensure input tax is only claimed on those cars meeting the
conditions noted above. The restriction of input tax includes delivery charges and fitted accessories.
Explanation
A car is any motor vehicle of a kind normally used on public roads which has three or more wheels and
meets one of the following conditions:
·
it is constructed or adapted mainly for carrying passengers
·
it has to the rear of the driver’s seat roofed accommodation which is fitted with side windows or which is constructed or adapted for
the fitting of side windows
Vehicles capable of accommodating only one person or capable of carrying twelve or more people (including
the driver) are not cars. Vehicles of not less than three tonnes unladen weight or with a payload of more than one tonne are also not cars.
For further information see
Reclaiming VAT - Vehicles and fuel costs
For further guidance see
VAT Input Tax VIT50000 Motoring Expenses
and section 3 of
Public
Notice 700/64 Motoring expenses.
back to checklist
13. Has input tax been restricted appropriately on the lease or long-term rental of cars
available for private use?
Risk
The recovery of VAT incurred on the lease or long-term daily rental of a car available for private use (other than a taxi
or for driving instruction) should normally be restricted to 50%.
Mitigation
Check input tax claimed against car leasing invoices and confirm that input tax has been restricted appropriately.
Explanation
Input tax on leased cars must normally be restricted by 50% unless the car is to be used exclusively for business purposes and will not be available for anyone’s private use.
For guidance on availability for private use see VAT Input
Tax VIT52700
and
VIT54800
If a car is purchased under a finance agreement (such as on hire-purchase or lease-purchase terms) which envisages the transfer of ownership, the transaction is treated as a purchase
for VAT purposes - see Q12.
If a business rents a self-drive hire car to replace a company car available for private use, the
50% restriction applies from the first day of hire. If a self-drive hire car is otherwise rented for no more than ten days
for specific business purposes, the 50% restriction does not apply.
Where a second-hand margin scheme car is leased, the 50% restriction does not apply.
Invoices issued by car leasing companies should indicate whether the 50% input tax restriction applies
to an individual car. Separately invoiced maintenance charges which are an optional addition to the basic lease agreement are not subject to the 50% input tax restriction and may be claimed as long as the car is used for business purposes.
For further guidance see
VAT Input Tax VIT53300
and section 4 of
Public
Notice 700/64
Motoring
expenses.
back to checklist
14. Has input tax been claimed correctly on the purchase of fuel for cars?
Risk
If a business purchases fuel for cars one of four options must be adopted for each car in respect of
the VAT incurred:
·
claim all of the VAT because the car is used exclusively for business journeys
·
claim all of the VAT and apply an output tax fuel scale charge based on the car’s CO2 emissions to reflect private use (rate set and
revised annually by HMRC)
·
maintain detailed records to separate business mileage from private mileage and demonstrate that fuel has only been provided for business
journeys
·
claim no VAT on
any road fuel purchased for any vehicles (both cars and commercial vehicles)
Mitigation
Identify cars for which fuel has been supplied and input tax claimed. Ensure output tax scale charges
are declared for each car unless business mileage records are maintained to separate business from private journeys or the car is used exclusively for business journeys. Confirm that current scale charges rates have been used. If maintained, review adequacy
of business mileage records.
Explanation
If input tax is recovered on the purchase of fuel for cars, the business must either prepare and retain adequate mileage records to demonstrate that fuel has only been provided
for business journeys or declare the appropriate output tax fuel scale charge for each car. The inclusion of sporadic fuel purchase invoices without supporting mileage records is not acceptable.
If total mileage is very low and the business opts to recover no input tax on any fuel and not declare
the appropriate scale charge, this option relates to all road fuel purchased by the business for both cars and commercial vehicles.
Generally all VAT incurred on vehicle repairs and maintenance can be claimed as long as there is some
business use of the vehicle and the business pays for the work.
For further guidance see
VAT Input Tax VIT54500,
VIT55400
and
VIT55700
and sections 8 and 9 of
Public
Notice 700/64 Motoring expenses.
back to checklist
15. Has input tax been correctly adjusted in respect of vehicles other than cars which
are available for private or non-business use?
Risk
Normal input tax rules apply to vehicles such as motorcycles, motor homes, vans and double cab pick-ups with a payload of more than one tonne
which are available for private use. Unless the Lennartz approach is adopted, the VAT on the initial purchase should be apportioned and only the business element claimed. For more information on the Lennartz approach see
Q8.
Double cab pick-ups with a payload of less than one tonne are classified as cars for VAT purposes -
see Q12.
Mitigation
Identify the extent of business use of vehicles other than cars. Ensure the input tax claimed is restricted
to the business element.
Explanation
If fuel is purchased for vehicles other than cars, the amount of VAT reclaimed should be restricted by
apportionment to the business element. Alternatively, all input tax may be claimed and output tax scale charges declared as for cars if preferred. If there is no business use of such a vehicle, no related VAT can be claimed.
Private use of a vehicle other than a car which is on a small and irregular scale and is incidental to
its main business use may be ignored.
For further guidance see
VAT Input Tax VIT50000 Motoring Expenses.
back to checklist
16. Has input tax been claimed correctly on business mileage payments to employees?
Risk
If mileage allowances are paid to employees for business journeys and input tax is claimed, the claims must be restricted to the fuel element of the mileage rate. Claims must be
supported by original fuel purchase invoices.
Mitigation
Ensure that any input tax claimed for business mileage allowances is restricted to the fuel element.
For guidance on an appropriate fuel element see
Company cars - advisory fuel rates.
Alternatively equivalent guidelines issued by organisations such as the AA or the RAC may be used.
Ensure that all claims are supported by original invoices.
For further guidance see section 8.7 of
Public Notice 700/64
Motoring expenses.
back to checklist
International Transactions
17. Has input tax been claimed correctly on goods imported from outside the European Union?
Risk
Input tax on goods imported from outside the European Union (EU) can be claimed where a
C79 certificate or acceptable alternative evidence is held. However, input tax is often claimed when the
evidence is unsatisfactory or the claim is duplicated.
Mitigation
Ensure a C79 certificate or alternative evidence that HMRC have agreed to accept is held to support input
tax claimed on the import of goods. Review cash book/shipping agents’ invoices to ensure duplications are avoided and that customs duty is not claimed as input tax. Ensure input tax is not claimed on imports such as cars and items to be used for business entertainment.
Explanation
When standard or reduced rate goods are imported from outside the EU, VAT is charged at the time of importation.
A monthly C79 certificate listing import VAT paid is normally sent to the declared importer and in most circumstances this certificate is the evidence required before input tax can be claimed. For more information on C79 certificates and details of imports
which do not appear on a C79, and of acceptable alternative evidence for input tax purposes, see section 8 of
Public Notice 702 Imports.
The VAT itemised on the C79 is subject to the normal input tax rules. Any customs duty paid along with import VAT cannot
be claimed.
Duplications often occur when claims are made against both the C79 certificate and the actual payment
of the VAT either against a disbursement invoice raised by a shipping or forwarding agent or deferred payment.
For further guidance see
Public Notice 702 Imports.
back to checklist
18. Has acquisition tax on goods acquired from a supplier in another European Union member
state been declared correctly?
Risk
If goods are acquired free of VAT from a supplier in another European Union (EU) Member State through
the provision of a UK VAT registration number, acquisition tax at the rate appropriate to the goods, if standard or reduced in the UK, must be declared in box 2 of the
VAT Return. The net value should also be declared in box 9.
The acquisition tax declared may be claimed as input tax subject to the normal rules. For example, the
purchase of a car free of VAT from a supplier in another Member State may result in the requirement to account for acquisition tax in box 2 of the return with no corresponding input tax claim in box 4 if the car is available for private use.
Mitigation
Review purchase records for evidence of goods acquired from suppliers in other EU states. Ensure that both acquisition tax and input tax have been correctly declared/claimed.
Confirm that the value of acquisitions has been included correctly in box 9 of the VAT Return.
Computerised accounting systems will often carry out necessary acquisition tax calculations and post appropriate
values to the VAT Return report. If so, it is important that the correct codes are set and that the appropriate VAT rate (standard, reduced or zero) is used to reflect the liability of the goods if supplied in the UK.
For further guidance see
VAT Single Market VATSM3300
and sections 7 and 8 of
Public
Notice
725 The single market.
back to checklist
19. Has input tax been accounted for correctly on services received from overseas suppliers?
Risk
If a business purchases a range of services from an overseas supplier it may be required to account for
output tax on that supply under the ’reverse charge mechanism’. This VAT, subject to the normal rules, may be recovered as input tax. This calculation is often overlooked or performed incorrectly.
Mitigation
Review purchase records for evidence of the purchase of services from an overseas supplier. Ensure reverse
charge calculations are correctly carried out and the input tax recovery is restricted if appropriate.
Explanation
The general rule regarding the place of supply of services changed on 1 January 2010 so that a business purchasing services from an overseas supplier is required to account for
tax on those services under the reverse charge mechanism.
Under the reverse charge mechanism output tax must be declared in box 1 of the VAT Return. This VAT, subject
to the normal rules, may be recovered as input tax in box 4.
There is a range of exceptions to this general place of supply rule which may remove the requirement to
carry out the reverse charge. These exceptions currently include services relating to land, the hiring of the means of transport, supplies involving admission to events and exhibitions, restaurant and catering services and some transport services. It is therefore
important to establish exactly what services have been performed to identify the correct treatment rather than relying wholly on the invoice wording.
For further guidance and details of the changes see
VAT Place of supply of services
and
Public
Notice 741A Place of supply of services.
back to checklist
Index
Introduction
Areas of risk within VAT partial exemption
Using links within the document
Checklist for VAT partial exemption
Explanation and mitigation of risks
Introduction
Tax agents and advisers play an important role in helping their clients to get their tax returns correct.
This toolkit is aimed at helping and supporting tax agents and advisers in completing VAT Returns on behalf of their clients, although it may also be of use to anyone who is completing a VAT Return. It may also be of use to tax agents and advisers who do not
complete their client’s VAT Return but wish to use it as a source of reference when advising their client on VAT matters or for reviewing their client’s VAT declarations at the year end.
This version of the toolkit was published in July 2016. The risks in this toolkit have been reviewed
and updated where necessary. Its use is entirely voluntary.
The content of this toolkit is based on our view of how tax law should be applied. Its application
to specific cases will depend on the law at the relevant time and on the precise facts.
For further information on using this toolkit and reasonable care under our penalty system see
Tax
agents toolkits.
For guidance on matters not dealt with in this toolkit you should refer to our full guidance in the
Partial Exemption Manual (PE)
Areas of risk within VAT partial exemption
A VAT registered business can reclaim the input tax that it incurs on expenditure which relates to supplies
which are:
·
UK taxable supplies (standard, zero or reduced rate).
·
Supplies made outside the UK which would be taxable if made in the UK.
·
Certain exempt supplies specified by Treasury Order known as 'specified supplies' which are a range of supplies made to persons belonging
outside the European Union (EU) that would be exempt finance or insurance supplies if made in the UK, supplies which relate directly to the export of goods to a place outside the EU or supplies made by intermediaries in relation to these types of supplies.
There are further 'specified' supplies relating to investment gold.
For the purposes of this toolkit all these supplies are referred to as 'taxable supplies' and the input
tax on the related expenditure as 'taxable input tax'.
Input tax which relates to exempt UK supplies or supplies that would be exempt if made in the UK (other
than 'specified supplies') cannot be claimed unless it is below a prescribed de minimis
2
Published July 2016
limit. These supplies are referred to in this toolkit as 'exempt supplies' and the related input tax
as 'exempt input tax'.
When a business makes only taxable supplies the process for claiming input tax is generally straightforward.
However, when a business incurs input tax that relates to both taxable and exempt supplies it becomes partly exempt. The partial exemption standard method sets out the mechanism for calculating how much input tax can be claimed in these circumstances and must
be followed unless an alternative special method is formally agreed with HMRC.
Record keeping
Good record keeping is essential, as poorly kept records can mean that the VAT Return is prepared on
the basis of inaccurate or incomplete information.
A partly exempt business must correctly determine the VAT liability of supplies it makes or intends
to make in order to correctly attribute its input tax for partial exemption purposes. The accounting system should therefore be adequate to ensure that all relevant transactions are identified and accurately recorded.
For further information on record keeping see
Record
keeping fact sheet.
Recognition of the need for a partial exemption calculation
Many businesses do not realise that they are partly exempt as they do not recognise that they are making or intending to make exempt supplies.
For a list of exempt supplies see Q2.
Alternatively a business may be unfamiliar with the partial exemption rules or conclude incorrectly that its exempt input tax is below the de minimis limit. A partly exempt business is only de minimis in any VAT period where its total exempt input tax is less
than £625 per month on average and no more than 50% of its total input tax, or it meets one of the simplified de minimis tests for smaller businesses - for further information see
section
11
of
Public
Notice
706 Partial exemption
(February 2014). It is common for a business to become partly exempt
as a result of exempt land and property transactions which may be outside its main business activities.
Attribution
In each VAT period a partly exempt business must allocate its input tax as fully and accurately as possible
to one of three categories:
·
directly attributable taxable input tax (incurred on expenditure only to be used to make taxable supplies and recoverable in full)
·
directly attributable exempt input tax (incurred on expenditure only used or to be used to make exempt supplies and not recoverable
subject to the de minimis rules)
·
residual input tax (incurred on expenditure that cannot be wholly attributed to either taxable or exempt supplies)
Most business overheads (such as accountancy fees and stationery) are generally residual, as is expenditure
which partly relates to both taxable and exempt supplies (such as an advertisement for both taxable and exempt products).
Residual input tax is sometimes referred to as being 'non-attributable' or 'the pot'.
While the principle of attributing input tax to use is straightforward, it can sometimes be difficult
to apply in practice. Whether any individual item of expenditure can be directly attributed to
3
Published July 2016
taxable or exempt use is a question of fact to be decided on the particular circumstances of each case.
Accurate attribution is also dependent on the understanding and consistency of the person entering individual purchases and expenses to the records, and errors can often occur
as a result of oversight or misunderstanding.
Apportionment
Once input tax has been directly attributed as far as possible to taxable and exempt use, the purpose of
any partial exemption calculation is to determine the proportion of residual input tax which is attributable to taxable supplies and can therefore be claimed.
The standard method, which apportions residual input tax on the basis of the ratio of the value of taxable supplies to total supplies, must be followed unless an alternative special
method has been formally approved by HMRC.
If a business considers that the standard method does not produce a fair apportionment of residual input
tax, it may apply to HMRC to use a special method. This toolkit does not address the detail of individual special methods which are particular to the circumstances of each business and must be considered accordingly.
Whether a business uses the standard method or an approved special method, the apportionment made should reflect
the way it uses the residual input tax to make supplies. The business should regularly consider whether its method remains a valid measure of that use. The annual adjustment may be a convenient time to do so.
The annual adjustment
Under the standard method a partly exempt business uses the recovery rate calculated under the previous
year's annual adjustment to apportion its residual input tax through the course of the current partial exemption tax year. A business may alternatively choose to carry out a separate partial exemption calculation for each monthly or quarterly VAT Return period.
Whichever approach is adopted, the amount of input tax claimed as a result of each period calculation is provisional and is only finalised through a 'longer period calculation' which is often known as the 'annual adjustment' and generally covers a period of
12 months. The annual adjustment uses the values for the whole of the period in question, comparing the result to the cumulative result of the individual return period calculations. It also accounts for any changes in use or intended use during the annual
adjustment period. Any resulting difference is payable to or recoverable from HMRC.
Adjustments to partial exemption calculations may also be required if input tax is claimed, or credit
notes issued or received, after the annual adjustment period to which they relate.
Changes of intention
Input tax is initially attributed on the basis of intended use. However, if a business subsequently changes
its plans and the liability of the intended use changes before actual use occurs, this initial attribution must be revisited. If the change of intention occurs after the end of the longer period in which the input tax is incurred, the required adjustment is
known as 'clawback' when input tax must be repaid to HMRC or 'payback' when additional input tax can be recovered. The need for such adjustments is often overlooked.
4
Published July 2016
Capital Goods Scheme
For most purchases the final level of input tax recovery is determined by the annual adjustment calculation.
However, for specified assets the level of taxable use must be monitored for up to five or ten years, with any variation in the extent of taxable use requiring an adjustment to the initial input tax deduction. The Capital Good Scheme (CGS) applies to purchases
of land and buildings where the value of the standard and reduced rate supplies received (excluding VAT) is £250,000 or more, and to purchases of computer equipment with a value of £50,000 or more (excluding VAT). With effect from 1 January 2011 the CGS has
been extended to include purchases of aircraft, ships, boats and other vessels with a standard or reduced rate value of £50,000 or more (excluding VAT). A business may either fail to identify assets subject to the CGS or make errors in the CGS calculation.
For purchases of items subject to the CGS which are made after 1 January 2011, the CGS calculation requires
adjustments to input tax in relation to changes in levels of non-business or private use of the asset in question, as well as to changes in levels of taxable and exempt use.
For more information on changes to the CGS see
Notice
706/2 Capital Goods Scheme
(September
2013).
Using links within the document
Blue underlined textare
links within this document.
Green bold text
are hyperlinks to external documents on the internet (access to the internet is
necessary to view these).
We have a range of services for people with disabilities, including guidance in Braille, audio and large
print. Most of our forms are also available in large print. Please contact any of our helplines if you need these services.
Dealing with HMRC if you have additional
needs
Giving HMRC feedback on Toolkits
HMRC would like to hear about your experience of using the toolkits to help develop and prioritise future changes and improvements. HMRC is also interested in your views of any
recent interactions you may have had with the department.
Send HMRC your feedback
5
Published July 2016
Client Name:
Period Ended:
Checklist for VAT partial exemption
|
Recognition of the need for a partial exemption calculation
|
Yes
No N/A
|
|
|
1
If exempt supplies are made or intended, has the
need for a partial
exemption calculation been recognised?
2
Has the VAT
liability of existing and intended suppliesbeen
correctly identified?
3
Have any necessary
adjustments for private or non-business use and
other restrictionsbeen
made before the partial exemption calculation is
carried out?
Attribution
4
Has input tax been
attributed correctlyto
taxable, exempt and residual use?
Apportionment
5
Has the
correct partial exemption methodbeen
used?
6
If a
special methodhas
been approved, has it been followed?
5
If residual input tax has been identified, has it been
apportioned
correctlyto
taxable and exempt use?
6
Published July 2016
6
Have the
correct supplies been included in the apportionment
calculation?
9
Does the amount of exempt input tax exceed the
de minimis limit?
|
The annual adjustment
|
Yes
No N/A
|
|
|
10
Has the
annual adjustmentbeen
calculated correctly?
11
Has the need to apply the
standard method overridebeen
considered?
7
Where there has been a
change of useor
intended use, has
the initia attribution been adjusted to reflect this?
7
If
credit noteshave
been issued or received, have any necessary partial exemption adjustments been made?
7
If
input tax has been claimed late,have
any necessary partial exemption adjustments been made?
15
Have
bad debt relief adjustmentsbeen
correctly treated?
7
Published July 2016
Capital Goods Scheme
8
Has the
need for Capital Goods Scheme adjustmentsbeen
considered?
17
Have Capital Goods Scheme
adjustments been calculated correctl?y
9
If a Capital Goods Scheme
item has been sold or otherwise disposed
ofwithin
its adjustment period, have any necessary adjustments been
made?
Explanation and mitigation of risks
Recognition of the need for a partial exemption calculation
1. If exempt supplies are made or intended, has the need for a partial exemption calculation
been recognised?
Risk
A business may not recognise that it is making or intends to make exempt supplies. For a list of exempt supplies
see Q2.Alternatively
a business may be unfamiliar with the partial exemption rules or mistakenly conclude that its exempt input tax is below the de minimis limit (see
Q9).
For example, a business which has been historically de minimis may incur unusually high levels of exempt input tax in refurbishing a number of exempt rental properties without realising that it
has now exceeded the de minimis limit and must carry out a partial exemption calculation to determine
how much input tax it can properly claim.
Mitigation
Consider all of the activities of the business, including those which are secondary or incidental, to identify existing or intended exempt supplies. If exempt supplies are identified,
ensure that a partial exemption calculation is carried out.
For an example of a partial exemption calculation using the standard method see paragraph 4.11,
Public Notice 706 Partial Exemption.
8
Published July 2016
Explanation
A business is partly exempt from the moment it first incurs input tax which relates wholly or partly
to exempt supplies. When a business is involved in property development, exempt input tax may be incurred long before the corresponding exempt supply is finally made.
If a business is using the Flat Rate Scheme for small businesses, no separate partial exemption calculation
is required. All exempt income must, however, be included in the turnover to which the appropriate scheme percentage is applied.
For further information see
Flat
Rate Scheme for VAT.
back to checklist
2. Has the VAT liability of existing and intended supplies been correctly identified?
Risk
Accurate partial exemption calculations depend on the correct VAT liability of existing or intended supplies
being identified. If a liability is incorrectly determined or recorded, the direct attribution of input tax (see
Q4)and/or
the apportionment of residual input tax (see Q7)may
be incorrect.
Mitigation
Review existing and intended business activities and consider whether the correct VAT liability has been determined. Confirm that the recording of zero-rated, exempt and outside
the scope income is accurate and consistent.
Explanation
Exempt supplies are listed in Schedule 9 to the VAT Act 1994:
11
Land -
VAT
Notice
742
12
Insurance
-
VAT
Insurance Manual
13
Postal Services -
Public
Notice 700/24 Postage and delivery charges
14
Betting, gaming and lotteries -
Public
Notice 701/29 Betting, gaming and lotteries
15
Finance -
VAT
Finance Manual
16
Education -
VAT
Education Manual
17
Health and welfare -
VAT
Health Manual
and
VAT
Welfare Manual
18
Burial and cremation -
VAT
Burial and cremation Manual
19
Trade
unions, professional and other public interest bodies -
VAT
Trade unions and
professional bodies Manual
20
Sport, sports competitions and physical education -
VAT
Sport Manual
21
Works of art etc.
Public
Notice 701/12: Disposal of antiques, works of art etc
22
Fund raising events by charities etc -
Fund-raising
events: Exemption for charities and
other qualifying bodies
23
Cultural services -
VAT
on Cultural Services Manual
24
Supplies of goods where input tax cannot be recovered (for example cars available for private use, assets used for business entertainment)
25
Investment gold scheme -
VAT
on Gold Manual
9
Published July 2016
12
Supplies of services by groups involving cost sharing
-
VAT
Cost Sharing Exemption
manual
For further information on VAT liability see
Rates
of VAT on different goods and services.
back to checklist
3. Have any necessary adjustments for private or non-business use and other restrictions
been made before the partial exemption calculation is carried out?
Risk
Any necessary adjustments for VAT incurred for private or non-business purposes must normally be made
before a partial exemption calculation. With effect from 1 January 2011, however, a business may apply to HMRC to use a formalised special method to apportion the VAT it incurs between business and non-business use (other than private use) as well as between
taxable and exempt use. For more information on special methods see Q5.
Input tax restrictions relating to cars available for private use and business entertainment must also
be applied before a partial exemption calculation.
Mitigation
Review input tax records to confirm that any necessary adjustments have been made before the partial
exemption calculation is carried out.
For further information see
Purchases
for both business and private use: reclaiming VAT.
back to checklist
Attribution
4. Has input tax been attributed correctly to taxable, exempt and residual use?
Risk
Whenever possible input tax should be directly attributed to taxable or to exempt supplies. Input tax
should, however, only be so attributed if the related expenditure is used or to be used exclusively for making such supplies. If expenditure cannot be wholly attributed to either taxable or exempt supplies, it must be classified as residual. Residual input
tax must be apportioned by the partial exemption method in use and not split artificially.
Mitigation
Consider the nature and circumstances of the business and review input tax records to ensure that input
tax has been accurately and consistently attributed to its use.
Explanation
In many cases the correct attribution of input tax is easily determined. For example, if a builder
is invoiced for a single supply of three pallets of bricks which will all be used in constructing a new house for resale, the related input tax can be wholly attributed to taxable use.
However, if the builder also purchases a cement mixer which he will use on both the new housing development
and also on the refurbishment of existing properties which he rents out (an exempt supply) it will have mixed use and the related input tax is consequently residual.
Residual input tax must be apportioned by the partial exemption method in use and not split artificially.
For example, if the builder is invoiced for a single supply of three pallets of bricks
10
Published July 2016
knowing that he will use two pallets in building a house for resale (taxable) and one pallet in repairing
the houses he owns and rents out (exempt), he cannot split the invoice on this basis - he must treat the input tax as residual and allow his partial exemption method to make the necessary apportionment.
Most overhead costs of a partly exempt business (such as rent, heat and light) are unlikely to be linked
to an individual taxable or exempt supply and are therefore normally classified as residual. However, if an overhead cost relates to an individual set of premises or a department which makes only taxable or exempt supplies (for example a shop making only taxable
retail sales or an office making only supplies of exempt insurance) the related input tax may correctly be attributed to taxable or exempt use.
Whether any individual item of expenditure can be directly attributed to taxable or exempt use is a question
of fact to be decided on the particular circumstances of each case. For further guidance on how to approach attribution in cases of difficulty see
PE21000.
If services purchased from overseas suppliers are accounted for under the 'reverse charge' mechanism,
the related input tax must be attributed to their use, not to the reverse charge declaration itself. Similarly, input tax on acquisitions of goods from suppliers in other European Union (EU) states must also be attributed to the use of the goods not to the
EU acquisition itself.
back to checklist
Apportionment
5. Has the correct partial exemption method been used?
Risk
A business must use the partial exemption standard method unless the use of an individual special method
has been formally approved by HMRC. The standard method must be followed precisely - any amendment creates a special method which requires prior approval.
Mitigation
Review the partial exemption calculation and ensure that the standard method has been followed, unless
HMRC has approved the use of a special method.
Explanation
In some circumstances the standard method calculation may not produce an apportionment of residual input
tax that accurately reflects the relative levels of taxable and exempt use and a business may apply to HMRC to use an alternative special method. For example, a special method may be appropriate when:
14
timing differences occur between incurring costs and making supplies
15
large one-off supplies distort the recovery rate
16
residual input tax is not used in proportion to the values of taxable and exempt supplies
A special method must result in the recovery of a proportion of residual input tax which fairly reflects
the degree of its taxable use. The method should be easy for the business to operate and for HMRC to check. An application to use a special method must be accompanied by a declaration that it will produce a fair and reasonable result.
With effect from 1 January 2011 a business may apply for a special method (known as a 'combined method')
which combines its business/non-business (other than private use) and
11
Published July 2016
partial exemption calculations. If the use of a combined method is approved, the normal de minimis limit
(see Q9)does
not apply and no exempt input tax is recoverable. For more information see
section
7, Notice 706 Partial Exemption (February 2014).
For further guidance on special methods see
PE40000.
For information on how to apply for a special method see
paragraph
6.2, Public Notice 706
Partial
Exemption (February 2014).
back to checklist
6. If a special method has been approved, has it been followed?
Risk
If a special method has been approved, it must be followed until the use of an alternative method is approved
by HMRC. If a business wishes to change its special method, a further application for a new special method must be submitted. If a business operating an approved special method wishes to revert to the standard method, it must also seek prior approval from
HMRC.
Mitigation
Confirm that if the use of a special method has been approved it has been followed unless a change of method has been approved by HMRC or a special method override notice (SMON)
has been served.
Explanation
If an approved special method ceases to produce a fair and reasonable recovery of input tax, either HMRC
or the business itself can serve a SMON (which requires residual input tax to be apportioned on the basis of 'use') to correct the position until a permanent replacement method is approved.
For further guidance on special methods see
PE40000.
back to checklist
7. If residual input tax has been identified, has it been apportioned correctly to taxable
and exempt use?
Risk
Once residual input tax has been quantified it must then be apportioned to determine the element which
relates to taxable supplies and can therefore be claimed. The basis for this apportionment is specified by the standard method and for most businesses should be rounded up to a whole percentage.
Mitigation
Review the apportionment of residual input tax to ensure that it has been performed correctly. If appropriate, confirm that the apportionment has been expressed as a percentage
and has been correctly rounded.
Explanation
For provisional quarterly or monthly calculations the final residual input tax recovery rate determined
under the previous year's annual adjustment (see Q10)must
be used unless a business chooses to carry out a separate calculation for each VAT Return period.
12
Published July 2016
If a separate apportionment calculation is carried out, the standard method specifies how it should be
performed and which supplies must be included - see Q8.
The recoverable proportion of residual input tax established by the calculation is expressed as a percentage
and is generally rounded up to the next whole number. However, if the business's average
monthly
residual input tax exceeds £400,000, the percentage is rounded to two decimal places.
In some circumstances, such as when the business has only recently registered for VAT or has become partly
exempt for the first time, the apportionment of residual input tax can be made on the basis of 'use'. For example, this may be appropriate if a newly registered business makes few or unrepresentative supplies during its first partial exemption year.
The input tax relating to the supplies of financial instruments such as shares and bonds falling within items 1 and 6 of Group 5 of Schedule 9 to the VAT Act 1994 must always be
ring-fenced and apportioned on the basis of 'use' outside the standard method calculation.
For further guidance on the standard method see
PE30500.
back to checklist
8. Have the correct supplies been included in the apportionment calculation?
Risk
The standard method apportions residual input tax on the basis of the ratio of taxable supplies to
total supplies. It also specifies that the value of certain supplies should always be excluded from this calculation. If the calculation incorrectly includes supplies which should be excluded (such as the sale of capital goods or incidental financial or real
estate transactions) or receipts which do not relate to supplies (such as insurance payouts or grants), the recoverable proportion may be understated or overstated and the incorrect amount of input tax claimed.
Mitigation
If residual input tax has been apportioned on the basis of supplies, review the calculation to ensure
that only the correct values have been included.
Explanation
For the purposes of the apportionment calculation the value of
taxable supplies
includes:
17
UK taxable supplies (net of VAT)
18
supplies made outside the UK which would be taxable if made in the UK
19
'specified supplies' - for further guidance see
PE11500
The value of
total supplies
additionally includes UK exempt supplies and supplies made outside the UK that do not carry the right to deduct input tax (essentially supplies that would be exempt if made in the UK other than 'specified supplies').
Certain values must always be excluded from the standard method apportionment calculation:
20
supplies of capital goods that have been used in the business
21
incidental real-estate and financial transactions
22
supplies of financial instruments and supplies from foreign branches - see
Q7
23
self-supplies (including 'reverse charge' supplies on services received from overseas and European Union acquisitions of goods)
13
Published July 2016
·
transactions where there is no supply for VAT purposes (such as transfers of going concerns - TOGCs)
·
Supplies made from establishments outside the UK (with effect from 1 January 2016)
For further guidance on excluded and incidental supplies see
PE32000.
back to checklist
9. Does the amount of exempt input tax exceed the de minimis limit?
Risk
The de minimis test allows a business with low levels of exempt input tax to treat itself as fully taxable
and to claim all its exempt input tax. A partly exempt business is only de minimis in any period where its total exempt input tax is less than £625 per month on average and no more than 50% of the total input tax for the period, or it meets the simplified
de minimis tests for smaller businesses (see explanation below).
Exempt input tax is the total of input tax wholly attributable to exempt supplies plus the exempt proportion
of residual input tax. A business may incorrectly conclude that it is de minimis on the basis of its directly attributable exempt input tax alone and omit to quantify and add in the exempt proportion of its residual input tax.
The de minimis limit is not an allowance. If the limit is exceeded in any period, no exempt input tax
can be recovered. The test should be applied at the end of each period calculation and again to the annual adjustment calculation.
Mitigation
Review the partial exemption calculation to confirm that the de minimis test has been correctly applied
to total exempt input tax.
Explanation
Under the annual test a business which is de minimis at the end of one tax year (see
Q10)may
provisionally treat itself as de minimis during the course of the following tax year, as long as this is applied through the course of the whole year and it has reasonable grounds for not expecting to incur more than £1 million input tax in the current year.
A full annual adjustment calculation is, however, required at the end of the tax year in question. If as a result of this calculation the business is not in fact de minimis, all exempt input tax must be repaid. Simplified de minimis tests are available to
businesses where either:
·
total input tax incurred is no more than £625 per month on average, and the value of exempt supplies is no more than 50% of the value
of all supplies
·
total input tax incurred less input tax directly attributable to taxable supplies is no more than £625 per month on average, and the
value of exempt supplies is no more than 50% of the value of all supplies
For further information see
section
11, Notice 706 Partial Exemption (February 2014).
There are no de minimis limits for VAT incurred before registration.
If a business is approved to operate a combined method to carry out its business/non-business calculation
as well as its partial exemption calculation, the normal de minimis limit does not apply and no exempt input tax can be recovered.
14
Published July 2016
When applying the de minimis limit a business should disregard any adjustments to input tax that result
from the Capital Goods Scheme.
For further guidance on de minimis see
PE24500.
back to checklist
The annual adjustment
10. Has the annual adjustment been calculated correctly?
Risk
The input tax which a partly exempt business calculates and claims in each monthly or quarterly VAT period
is provisional and must be finalised through a longer period calculation and adjustment. The longer period adjustment is commonly known as the 'annual adjustment' and normally covers a partial exemption tax year, although in some circumstances it may be shorter
or longer.
If a newly registered or newly partly exempt business has made provisional calculations on the basis of
'use' (see Q7),
the annual adjustment calculation must also be made on this basis. Otherwise the standard method annual adjustment calculation must apportion residual input tax using the value of supplies - see
Q7.
Mitigation
Confirm that an annual adjustment calculation has been carried out at the end of the partial exemption
tax year and that any necessary adjustment has been declared on an appropriate VAT Return. Review the calculation to ensure that:
·
the attribution of input tax has been adjusted to reflect any change in use or intended use
·
the amount of residual input tax that can be claimed over the course of the longer period has been recalculated using the value of supplies
for the whole period
·
the de minimis test has been reapplied to see whether the business can be treated as fully taxable over the longer period
Compare the result of the annual adjustment calculation to the cumulative total of the provisional period
calculations. Any difference is the annual adjustment and can be declared on either the final VAT Return of the longer period itself or on the VAT Return for the first period following it.
Explanation
The annual adjustment repeats the attribution and apportionment process using the values for the whole
of the period in question. In doing so, it eliminates any seasonal fluctuations in the value and mix of supplies and in levels of residual input tax. For example, a business may have been treated as de minimis in one or more individual return periods but then
establish that it is not de minimis for the longer period as a whole - or vice versa.
A longer period calculation must be carried out at the end of the business's partial exemption tax year,
which is a calendar year normally ending on 31 March, 30 April or 31 May depending on the business's normal VAT Return periods. If a business makes monthly returns their tax year ends on 31 March. An alternative tax year (and longer period) can be agreed with
HMRC (for example to tie in with a business's financial year end).
For further guidance on the longer period see
PE30000.
15
Published July 2016
back to checklist
11. Has the need to apply the standard method override been considered?
Risk
The standard method override only applies to larger businesses with annual residual input tax exceeding
£50,000 (or £25,000 for group undertakings which are not members of the same VAT group). For such businesses, an override applies if the standard method does not produce a fair and reasonable apportionment of residual input tax - see explanation below. A business
may fail to consider the application of the override when appropriate.
Mitigation
The application of the standard method override normally should normally be considered alongside the
longer period calculation. If total residual input tax exceeds £50,000 (or £25,000 for group undertakings which are not members of the same VAT group), consider whether the standard method provides a fair apportionment of residual input tax. If it does not,
the standard method override must be applied.
Explanation
A standard method apportionment does not produce a fair apportionment of residual input tax if the result it produces is substantially different from the amount that would be recovered
if a 'use' based apportionment were applied. A difference is substantial if it exceeds the lower of
·
£50,000
·
£25,000 and 50 per cent of the total residual input tax incurred
For further guidance on the standard method override see
PE32500.
back to checklist
12. Where there has been a change of use or intended use, has the initial attribution
been adjusted to reflect this?
Risk
If input tax is initially attributed on the basis of intended rather than actual use and that intention
changes after the end of the annual adjustment period in which it is incurred but before actual use occurs, the attribution must be adjusted. Such an adjustment is known as 'clawback' if input tax must be wholly or partly repaid to HMRC and 'payback' if additional
input tax may be claimed. In addition to situations where intention changes from taxable to exempt use (or vice versa), clawback and payback also apply when there is a change from a mixed use intention to an intention to make wholly taxable or wholly exempt
supplies or vice versa.
For VAT incurred on or after 1 January 2011, the clawback and payback rules have been extended to cover changes in intended non-business
or private use as well as changes in intended taxable and exempt use. For more information see
PE61100
and Q7 of the
VAT
Input
Tax Toolkit.
Changes in intended use often occur in property development where projects can take several years
from planning to completion and the final VAT liability may be subject to change.
Mitigation
Consider any changes or planned changes in business activities. Identify expenditure to which clawback
or payback may apply and ensure that any necessary adjustments are made using
16
Published July 2016
the partial exemption method and values for the longer period in which the input tax was originally incurred.
Clawback and payback adjustments must be considered for a period of six years commencing on the first
day of the VAT Return period in which the input tax was incurred.
A proposed payback claim must be submitted to HMRC for approval.
If a project is wholly abortive and the related goods and services are not used to make any supply, there
is no requirement to adjust the initial input tax attribution.
Example
A property developer initially attributes the costs of constructing a new office block to taxable use
on the grounds that it is his intention to make a taxable freehold sale of a new building. Two years into the project he concludes that market conditions now favour him retaining ownership of the block to rent out without exercising an option to tax. He has
now changed the intended use of the input tax he has incurred to exempt supplies and a clawback adjustment is required.
House builders intending to make wholly taxable (zero rated) freehold sales of new dwellings may find
themselves forced by unfavourable market conditions to make temporary short term lets of the properties in question while retaining the underlying intention to make taxable sales.
For further information on partial exemption in this scenario see
VAT
Information Sheet 7/08 and
Revenue
& Customs brief 101/09.
For further guidance on changes in intention or use, clawback and payback see
Partial
Exemption Manual - PE61000.
back to checklist
13. If credit notes have been issued or received, have any necessary partial exemption
adjustments been made?
Risk
If a sales credit note (taxable or exempt) is issued in the same VAT Return period or partial exemption
longer period as the sales invoice to which it relates, the effect of the credit note will be accurately reflected. However, if the credit note is issued after the end of the longer period in which the original supply occurred, the outputs ratio used to apportion
residual input tax may be distorted.
Similarly, if a purchase credit note carrying VAT is received and/or posted after the end of partial exemption
longer period in which the purchase invoice to which it relates was received, it may be subject to a higher (or lower) residual recovery rate than that applying to the original purchase invoice.
Mitigation
Review records for credit notes issued or received by the business which adjust a supply made or received in
an earlier longer period. If appropriate, rework the partial exemption calculation for the period in which the underlying supply occurred, including the credit note, and adjust input tax accordingly, reviewing the application of the de minimis test if appropriate.
Explanation
For further guidance see
PE62750.
back to checklist
17
Published July 2016
14. If input tax has been claimed late, have any necessary partial exemption adjustments
been made?
Risk
If a business makes a late claim for input tax, it is only recoverable to the extent that it would have
been recoverable had it been claimed in the period in which it was incurred. The annual adjustment for the tax year in question may consequently need to be recalculated and the de minimis test reapplied. For example, a business which was previously below the
de minimis limits for a tax year may in some circumstances exceed them when the belated input tax claim is taken into account - in such circumstances all exempt input tax for the year in question becomes irrecoverable.
Mitigation
Review records for late input tax claims. Review the partial exemption calculation for the period in which
the entitlement to input tax arose and ensure that input tax is adjusted accordingly. If the business was originally found to be de minimis for the longer period in question, confirm that this still applies.
Explanation
For further guidance see
PE63250.
back to checklist
15. Have bad debt relief adjustments been correctly treated?
Risk
If a partly exempt business claims bad debt relief in respect of unpaid sales, it should not reduce the value of turnover used to apportion residual input tax. The non-payment
of the invoices in question does not alter the use to which the related expenditure was put.
If a partly exempt business is required to repay input tax claimed on expenditure which remains unpaid
after six months, the amount to be added back should reflect the proportion originally claimed. For example, if an unpaid item of expenditure was attributed to exempt use and no input tax was claimed, there is no requirement to add back any input tax.
Mitigation
Review VAT Return calculations for bad debt relief adjustments and ensure that they have been treated correctly.
For further guidance see
PE64000.
back to checklist
Capital Goods Scheme
16. Has the need for Capital Goods Scheme adjustments been considered?
Risk
Certain land and computer assets are subject to the Capital Goods Scheme (CGS) and the extent of taxable
use must be monitored over a specified period. With effect from 1 January 2011 the CGS has been extended to apply to purchases of aircraft, ships, boats and other vessels over a specified value. For items subject to the CGS where the input tax is incurred
on
18
Published July 2016
or after 1 January 2011, a CGS adjustment is also required to reflect any change in the level of non-business
or private use.
A business which owns a CGS item and is partly exempt, or becomes partly exempt during the specified period, may omit to make the necessary
adjustments to reflect any increase or decrease in the extent of taxable business use of the asset in question. A CGS adjustment may also be required if a CGS item is sold or partly sold during the specified period - see
Q18.
Mitigation
Identify assets which are subject to CGS adjustments. Ensure that the need for a CGS adjustment is reviewed
annually at the correct time - any necessary CGS adjustment must be declared on the return for the second VAT period after the end of the annual adjustment period to which it relates. For example, if a business on quarterly VAT Returns has an annual adjustment
period ending 31 March, any necessary CGS adjustments are due on the return for the period ending 30 September.
Explanation
Assets subject to the CGS are referred to as 'capital items'. Only items used in the business are subject
to the CGS - items for resale are excluded.
The CGS applies to capital expenditure on land and buildings with a value of £250,000 or more (exclusive of VAT) which was subject to VAT at the standard or reduced rate. The purchases
in question are:
·
an interest supplied to an owner in land, a building or part of a building or a civil engineering work
·
expenditure incurred in the construction of a building, part of a building or a civil engineering work
·
alterations, extensions and annexes to buildings which increase the existing floor space by 10 per cent or more (for input tax incurred
on or after 1 January 2011 the CGS definitions relating to such expenditure have been simplified to remove the floor space element of the applicable definitions)
·
for input tax incurred on or after 1 January 2011, the CGS has been extended to include alterations, extensions and annexes to civil
engineering works
·
capital expenditure on services and goods affixed to the building in the course of refurbishing or fitting out a building (for input
tax incurred on or after 1 January 2011 it no longer matters whether goods are affixed to a structure or not, only whether the expenditure has been capitalised)
·
for input tax incurred on or after 1 January 2011 the CGS has been extended to include refurbishments of civil engineering works
·
an interest supplied to the owner, or expenditure incurred, in constructing a civil engineering work
The CGS also applies to any computer with a VAT exclusive value of £50,000 or more. 'Computer' means
a single item of equipment rather than a complete network. Computer software and computerised equipment are not included.
With effect from 1 January 2011 the CGS has been extended to apply to capital expenditure on aircraft,
ships, boats and other vessels with a VAT exclusive value of £50,000 or more. As well as VAT incurred in respect of the purchase of such assets, the scheme also includes VAT incurred in the course of their manufacture, refurbishment, fitting out or alteration.
19
Published July 2016
From 1 January 2011 the value threshold for determining whether an asset is subject to the CGS is the total expenditure on the asset in question, not the business related expenditure
alone.
If an asset purchased on or after 1 January 2011 is wholly or partly excluded from the business's assets
and treated wholly or partly as a private asset with no related VAT being claimed (sometimes referred to as 'the Armbrecht option'), only the value of the business element of the asset is taken into consideration in deciding whether a CGS item exists. For
such assets which are subject to the CGS, there is no subsequent input tax adjustment required in respect of the element of the asset kept outside the business.
A business does not have to be partly exempt or (for items purchased after 1 January 2011) have non-business
activities when it purchases an item for the CGS to apply. For example, a company may use a building purchased for £300,000 plus VAT for wholly taxable purposes for six years. In year seven it diversifies into an exempt activity - for example insurance - and
bases its new insurance team in this building. The building remains subject to the CGS and CGS adjustments may now be required.
For further information see
Public
Notice 706/2 Capital Goods Scheme.
back to checklist
17. Have Capital Goods Scheme adjustments been calculated correctly?
Risk
While a business may recognise that it owns assets subject to the Capital Goods Scheme (CGS), it may
carry out the necessary calculation incorrectly. Calculation errors can include:
·
wrongly identifying the baseline recovery rate for the asset in question
·
applying the wrong adjustment period to the asset in question
·
wrongly calculating the adjustment percentage to apply for the period in question
For further information on the CGS calculation and a worked example see sections 5, 6 and 7 of
Public
Notice 706/2 Capital Goods Scheme.
Mitigation
Review CGS calculations to ensure they have been correctly performed.
Explanation
The period over which a person is required to review the extent of taxable use (and/or non-business use
for input tax incurred on or after 1 January 2011) of an item under the CGS is called the adjustment period. The adjustment period is split into a number of intervals - these are normally years and aligned with the business's partial exemption tax years. The
adjustment period for land, buildings and civil engineering works is normally ten intervals. For computers, aircraft, ships, boats and other vessels, the adjustment period is normally five intervals.
With effect from 1 January 2011, if a business's interest in an asset is more than one year less than
the normal CGS adjustment period (for example a business acquiring a seven year interest in a building falling within the CGS) the CGS adjustment period for that asset is reduced to the number of complete years of the interest held plus one (in the example
given the period of adjustment for the building in question will be eight intervals). This change applies to CGS items for which the first period of adjustment has not commenced prior to 1 January 2011. For further information see
section
6.3
of
Public
Notice 706/2 Capital Goods Scheme.
20
Published July 2016
The initial level of input tax to be recovered in respect of the CGS item (the 'baseline') is determined
by the business/non-business calculation (for assets purchased after 1January 2011) and the partial exemption annual adjustment calculation for the period in which the item is first used. There is no separate CGS calculation at this time.
If input tax is incurred on a CGS item before the first interval (for example during the early
stages of a construction project) see
paragraph
7.6
of
Public
Notice 706/2: Capital Goods
Scheme.
In each of the subsequent intervals (between two and nine depending on the individual item and when it
was acquired) the extent of taxable use (and/or non-business use if the item was purchased after 1 January 2011) determined under the longer period partial exemption calculation (and/or business/non-business calculation if applicable) is compared with the
initial level of input tax claimed. The difference is called the 'adjustment percentage'. The actual input tax adjustment (if any) required in a subsequent interval is calculated as:
original input tax incurred
x adjustment percentage
number of intervals applying to the item
In any subsequent interval where the longer period calculation finds the business to be de minimis any exempt
business use in that period is generally ignored for CGS purposes. If, however, the Standard Method Override (see
Q11)would
have been triggered had all the input tax on the item been incurred in the year in question and treated as de minimis, this is not the case.
back to checklist
18. If a Capital Goods Scheme item has been sold or otherwise disposed of within its adjustment
period, have any necessary adjustments been made?
Risk
If a business sells or otherwise disposes of a capital item or part of the item before the end of its full
adjustment period, the Capital Goods Scheme (CGS) adjustment for the interval in which it sells the item is the final adjustment. The final adjustment must also include a further adjustment to take account of any remaining unused intervals. If the sale of
the item is a taxable supply, its use in all the remaining intervals is treated as 100% taxable. If the sale is exempt, its use in all remaining intervals is treated as being 100% exempt.
Mitigation
Establish whether a CGS item has been sold during the longer period under review. If so, confirm that
the necessary CGS adjustment for unused intervals is correctly calculated and declared.
Example
A partly exempt company purchases an office block for £1 million plus VAT of £200,000. It does not opt
to tax the building. The block is used for both taxable and exempt purposes. In its first longer period its residual input tax recovery rate is 50% and the amount of VAT recovered on the building is therefore £100,000. In each of the subsequent four intervals
(in practice, years) the residual input tax recovery rate remains constant at 50% and no CGS adjustment is required. Shortly before the end of the last of these intervals (the fifth year of use) the block is sold. In the absence of an option to tax the sale
is exempt. In addition to the CGS adjustment required for the fifth period itself (in this case nil because the level of taxable use has remained
21
Published July 2016
consistent at 50%) a further CGS adjustment is also required in respect of the five remaining unused intervals.
As the sale is exempt the extent of taxable use for these intervals is 0%. The adjustment percentage is therefore 50%, being the difference between the initial recovery rate (50%) and the extent of taxable use for the remaining periods (0%). The amount of
input tax which must be repaid to HMRC as a CGS adjustment is therefore:
£200,000 x 5x
50% = £50,000 10
Explanation
If a CGS item is wholly or partly stolen, lost or destroyed before the end of its adjustment period the final CGS adjustment for the part lost is the one for the period in which
this event occurs. No further adjustment is required in respect of remaining unused intervals.
For further information on the disposal of a CGS item see section 9 of
Public
Notice 706/2
Capital
Goods Scheme.
For further information on CGS items forming part of a transfer of a going concern (TOGC) see section 9 of
Public
Notice 706/2 Capital Goods Scheme.
For further information on CGS items on hand at deregistration before the adjustment period ends see section
9.6 of Public
Notice 706/2 Capital Goods Scheme.
back to checklist
22
Published July 2016