Partial exemption – changes to the special method rules.
31-05-2007
Many VAT registered businesses, especially in the charitable and not for profit sector, are in receipt of income which is exempt from VAT. This can include income from education, health and welfare activities. Where a VAT registered entity is in receipt of exempt income it will be partly exempt for VAT purposes and will therefore have to undertake regular partial exemption calculations.
Many businesses will operate the standard income based partial exemption method, which can be adopted without approval from HM Revenue & Customs (HMRC). However, as this is a broad-brush method it can be unfair to either the business or to HMRC. In such cases the business can apply for (or HMRC may impose) a special method.
Approval of a special method can take some time, usually months and sometimes years. HMRC has therefore reviewed its procedures and has implemented a new requirement with effect from 1 April 2007.
New requirement for special methods
When a VAT registered business applies for a special method it will have to make a declaration that, to the best of its knowledge and belief, the method is fair and reasonable.
HMRC believes that the requirement to make such a declaration will speed up the approval process. However, there will be downsides for businesses:
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If HMRC subsequently decides that the method is not fair and reasonable, and the business ought to have known this when they applied for it, they can set the method aside and assess the business for overclaimed VAT since the date that the method was first used. Penalties and interest could also apply.
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There is no reverse process, i.e. if the business subsequently identifies that an alternative method would have produced a higher level of VAT recovery, they cannot retrospectively amend the method.
What action should partly exempt businesses take?
Any business which is partly exempt should regularly review its partial exemption method to ensure it continues to provide the most cost effective outcome within the rules.
If a business decides that a new method is required they must be prepared to make the new declaration. Whilst most businesses have applied the fair and reasonable principle in the past, it will be much more important in the future for the person who has signed the declaration to ensure that they have taken all necessary steps to acquaint themselves with the relevant rules, both at the time of applying for the method and following its implementation. Any changes in the business which could make the method unfair must be identified and notified to HMRC.
VAT Liaison has been involved in agreeing many partial exemption special methods for our clients and we would be happy to review your circumstances. If you would like to discuss how we can help please contact your usual VAT Liaison contact or our VAT Helpline on 0800 700 652.