Assistance to Businesses which are VAT registered and operate under Partial Exemption Rules

HMRC has released details of a new fast-track process for seeking approval for a temporary change to a partial exemption method. This potentially gives scope for additional VAT amounts to be recovered by organisations whose VAT recovery has been severely reduced by changes to their activities brought about by COVID and the associated government restrictions.

A temporary change in VAT recovery method could significantly increase VAT recovery for partially exempt businesses, charities and membership organisations including Sports Clubs and Golf Clubs.

Background – Partially Exempt Businesses/Clubs

Businesses which make a mixture of taxable and exempt supplies can only recover input tax to the extent that it is used in making taxable supplies. The element of VAT relating directly to taxable supplies can be recovered whereas the element not relating directly to taxable supplies must be apportioned using a fair and reasonable method to calculate the percentage which is recoverable. In most cases, this allocation requires a calculation to be carried out to apportion the VAT based on Taxable income divided by total income (taxable plus exempt) This calculation is known as the standard basis of partial exemption calculation and is the default method.

However, if you are not satisfied that this gives a fair and reasonable recovery you can request a ‘Partial Exemption Special Method’ (PESM) which has to be agreed by HMRC.

During COVID, the standard method of calculation may no longer reach a fair conclusion if the business in the year has fundamentally changed due to COVID-19 restrictions. For example, a golf club may earn most if its taxable income from the Bar and Catering which have been closed due to the government restrictions. This will mean that any calculation using the split of income between Taxable and Non-Taxable may not give a fair way of calculating the VAT that can be recovered in the business/Club. Therefore, an alternative calculation and adjustment would be appropriate – albeit on a temporary basis.

In such cases, the way to achieve a temporary method differs depending on whether the business is using the standard or special method.

Standard method

In normal times, there is an automatic adjustment required for businesses operating the standard method where the result differs from a fair and reasonable ‘use based’ calculation by more than a fixed amount (i.e. the difference is more than £50k or more than 50% of the overall residual input tax and £25k).

Any organisation using the standard method should, therefore, consider if the amount of VAT it can recover is still ‘fair and reasonable’ given the changes caused by COVID. If they do not think it is then:

• If the figure comes within the amounts above then they can apply for standard Override
• If not then they can apply for a temporary change to a PESM which may just consist of looking at the % that they could claim in the previous year with normal trading.

The most appropriate time to complete the calculation is at the time of the annual adjustment calculation which is required for Partially Exempt Entities.

Special method

An adjustment to the special method generally requires agreement by HMRC. The information released by HMRC states that applications for changes to the method of calculation due to COVID issues will be considered quickly. Requests, which must include a proposal for a suitable alternative method of calculation, should be sent to PESMcovid19@hmrc.gov.uk

Where HMRC are satisfied that the aim of the proposal is to address Coronavirus issues only, HMRC will restrict its enquiries to how that proposal addresses those issues.

Where there may be a significant risk that the remainder of the existing method produces an overall result which is not fair and reasonable, further examination of that method may be considered.

Where supplies made have changed as a result of coronavirus, but are anticipated to move back toward a pre-pandemic position in due course, HMRC say they are likely to accept proposed temporary methods that:

• Use representative income streams from the previous tax year or potentially an average of the last three years before the pandemic to get a fair and reasonable recovery rate

Any changes to methods will have a time limit stating that, subject to any other changes, the method will revert to the previous calculation, or for previous standard method users will end, after that point. The default time will be one year but if it is apparent that the timeline is not sufficient then you can submit a further request to continue the changes into a second tax year.

The information in this blog provides only an overview of HMRC guidance and legislation in force at the date of publication and no action should be taken without consulting the detailed HMRC guidance and legislation or seeking professional advice.  Therefore no responsibility for loss occasioned by any person acting or refraining from action as a result of the material contained in this blog can be accepted by the firm.