VAT – what is partial exemption?

A business that incurs expenditure on taxable and exempt business activities is partially exempt for VAT purposes. This can happen where a business makes or intends to make both taxable and exempt supplies and incurs input tax that relates to both kinds of supply. Under this scenario, the business must make an apportionment between the activities using a 'partial exemption method' to calculate how much input tax is recoverable.

There are a number of partial exemption methods available. The standard method of recovering any remaining input tax is to apply the ratio of the value of taxable supplies to total supplies, subject to the exclusion of certain items which could distort the calculations. The standard method is automatically overridden where it produces a result that differs substantially from one based on the actual use of inputs. It is possible to agree a special method with HMRC.

The VAT incurred on exempt supplies can be recovered subject to two parallel de-minimis limits.

The tests are met where the total value of exempt input tax:

  1. Is under £625 a month (£1,875 a quarter/£7,500 a year); and
  2. Is less than half of the total input tax incurred.

If both tests are met the VAT can be recovered. Businesses that are partially exempt, need to complete this calculation on a quarterly basis as well as completing an annual calculation.

Building a new home and VAT

The VAT DIY Housebuilders scheme is a special scheme that enables someone building their own home to benefit from special VAT rules that allow the qualifying construction costs of new homes and certain conversion works to be zero-rated. The scheme has been designed to effectively place DIY housebuilders in a similar VAT position to a property developer.

A claim can be made for qualifying building materials on which VAT has been charged. Qualifying materials include most materials incorporated into a new building or conversion which cannot be easily removed. There are exceptions including fitted furniture, carpets, and certain domestic appliances.

It is not possible to claim the VAT for any professional or supervisory services associated with the development. There are also time limits that should be adhered to when making a claim. A claim must usually be made within three months of the completion of the conversion or new building using the appropriate form. A repayment is usually made within 30 days of a claim being submitted.

There are two main forms for making a claim. The first form (VAT 431NB) is designed for new builds and the second form (VAT431C) is designed for qualifying conversions i.e., the conversion of a non-residential property to residential.

Who can use the VAT retail schemes?

VAT retail schemes are a special set of schemes used by retail businesses to account for VAT.  The schemes are used by businesses that sell a significant amount of low value and/or small quantity items to the public with different VAT liabilities.

The use of the schemes can save businesses a significant amount of time in calculating the amount of VAT due to HMRC. In many circumstances, it would be extremely difficult for these businesses to account for VAT using standard VAT accounting. By using the VAT retail scheme, retailers can calculate VAT due to HMRC at the standard, reduced and zero rates of VAT as a proportion of sales. Usually this is done on a day-by-day basis.

There are 3 standard VAT retail schemes:

  • Point of Sale Scheme
  • Apportionment Scheme
  • Direct Calculation Scheme

There is also the option of using a bespoke scheme. The use of a bespoke scheme is obligatory for retailers with a turnover excluding VAT of £130 million or more. The decision as to which retail scheme is to be used is usually driven by a combination of looking at the scheme that provides the best result for the business in question combined with the cost of using the scheme, with the important caveat that HMRC consider that the chosen scheme is fair and reasonable.

HMRC’s guidance on the 3 standard schemes and the bespoke scheme has recently been updated to include information about changes to the treatment of vouchers.

What is distance selling for VAT purposes?

Distance selling is the term used to describe supplies of delivered goods from one EU Member State to a customer in another member state who is not registered for VAT. 

The recipients of most distance sales will be private individuals, but they can also include small, unregistered businesses, businesses making only exempt supplies, charities and public bodies.

Following the Brexit terms, distance selling can still occur on the movement of goods between the EU and Northern Ireland. Under the terms of the agreement there can be distance selling for VAT purposes when a business supplies and delivers goods to a customer who is not registered for VAT from:

  • an EU country to Northern Ireland
  • Northern Ireland to an EU country
  • one EU country to another EU country

The UK distance selling threshold is £70,000 per calendar year. If the value of a supplier’s distance sales into Northern Ireland is under this level, then VAT should be charged at the rate that applies in the seller's home country. If the value of the distance sales goes over the threshold the supplier must register for UK VAT and start accounting for UK VAT. They may also apply for a voluntary registration if their sales are under £70,000 in the calendar year.

The distance selling rules are intended to combat distortion of trade and unfair competition by transferring the place of supply to the Member State in which the customer receives the goods.

One month left to join VAT Deferral Payment Scheme

Businesses that deferred VAT payments last year have until 21 June 2021 to join the new online payment scheme. This would allow them to spread the cost of repayment over a number of months. The VAT deferral scheme is open to businesses that took the option to defer the payment of their VAT liabilities between 20 March 2020 and 30 June 2020. 

Under the scheme, businesses have the option to pay their deferred VAT in smaller payments over a longer period and interest free. Instead of having to repay the full amount by 31 March 2021, businesses can make smaller interest-free payments during the 2021-22 financial year and complete payment of any arrears by 31 March 2022. 

The maximum number of instalments allowed under the scheme is based on the date businesses sign up for the scheme. The first instalment must be paid on joining the scheme. The March, April and May joining dates have passed but businesses that join by 21 June 2021 (the last available date) can pay in eight instalments.

Businesses must also meet certain conditions to use the scheme including being up to date with their VAT returns. HMRC has confirmed that businesses may be charged a 5% penalty or interest if they do not pay the VAT in full, sign up to the scheme or arrange to pay by 30 June 2021.

When not to charge VAT

When a VAT registered business issues an invoice to their customer, they must ensure that they charge the correct rate of VAT. Whilst most businesses in the UK charge VAT at the standard rate of 20% there are a number of different VAT rates and exemptions to be aware of; this includes the reduced VAT rate of 5% and the positive zero rate (0%).

There are two other categories that the supplies of goods and services can fall under:

  • Exempt – where no VAT is charged on the supply. Examples of exempt items include the provision of insurance, postage stamps and health services provided by doctors. If a business only sells VAT-exempt goods and services, they cannot register for VAT.
  • Supplies that are 'outside the scope' of the UK VAT system altogether. These supplies are beyond the realm of the UK VAT system and you cannot charge or reclaim VAT on these supplies. Examples include goods or services you buy and use outside the EU, statutory fees – like the London congestion charge and goods you sell as part of a hobby.

If a business has made an error in charging VAT, then this needs to be corrected. The timing of finding an error can impact on how the issue is resolved.

There are also penalties if you charge VAT to your customers before you are officially registered. VAT registration is only required for eligible businesses earning more than £85,000 per year although businesses under the threshold can voluntarily apply for a VAT registration.

Charging VAT on discounts and free gifts

When VAT registered traders issue an invoice to a customer, they must seek to ensure that the correct rate of VAT is charged. Whilst most businesses in the UK charge VAT at the standard rate of 20% there are a number of different VAT rates and exemptions that need to be observed.  In the UK, there are three separate VAT rates, the standard rate @ 20%, the reduced rate @ 5% and the zero rate @ 0%.

Also, there are special rules to be aware concerning VAT to charge when there are discounts or free gifts. The rules are complex, but we have summarised the main aspects below.

Discounts and free gifts

Offer   How to charge VAT
Discounts      Charged on the discounted price (not the full price)
Gifts   Charged on the gift’s full value. There are some specific exceptions on gifts given to the same person if their total value in a 12-month period is less than £50.
Multi-buys   Charged on the combined price if all the items have the same VAT rate. If not, VAT is ‘apportioned’ as mixed-rate goods
Money-off coupons, vouchers etc No VAT due if given away free at time of a purchase. If not, VAT due on the price charged
‘Face value’ vouchers that can be used for more than one type of good or service ‘Face value’ vouchers that can be used for more than one type of good or service No VAT due, if sold at or below their monetary value
Redeemed face value vouchers Charged on the full value of the transaction
Redeemed face value vouchers sold at a discount Charged on the discounted value of the transaction
Link-save offers (buy one get one free or discounted) VAT is apportioned as mixed-rate goods – there are exceptions

VAT – transfer as a going concern

The transfer of a business as a going concern (TOGC) rules concern the VAT liability of the sale of a business. Normally the sale of the assets of a VAT registered or VAT registerable business will be subject to VAT at the appropriate rate.

Where the sale of a business includes assets and meets certain conditions the sale will be categorised as a TOGC. A TOGC is defined as 'neither a supply of goods nor a supply of services' and is therefore outside the scope of VAT. Under the TOGC rules no VAT would be chargeable on a qualifying sale.

All the following conditions are necessary for the TOGC rules to apply:

  • The assets must be sold as part of a 'business' as a 'going concern'. In essence, the business must be operating as such and not just an 'inert aggregation of assets'.
  • The purchaser intends to use the assets to carry on the same kind of business as the seller.
  • Where the seller is a taxable person, the purchaser must be a taxable person already or become one as the result of the transfer.
  • Where only part of a business is sold it must be capable of separate operation.
  • There must not be a series of immediately consecutive transfers.
  • There are further conditions in relation to transactions involving land.

The TOGC rules can be complex, and both the vendor and purchaser of a business must ensure that the rules are properly followed. The TOGC rules are also mandatory which means that it is imperative to establish from the outset whether a sale is or is not a TOGC. For example, if VAT is charged in error, the buyer has no legal right to recover it from HMRC and would have to seek to recover this 'VAT' from the seller.

Correcting errors on VAT returns

Where an error on a past VAT return is uncovered, businesses have a duty to correct the error as soon as possible. As a general rule, any necessary adjustment can be made on a current VAT return. However, in order to be able to do so, there are three important conditions that must be met:

  1. The error must be below the reporting threshold.
  2. The error must not have been deliberate.
  3. The error can only relate to an accounting period that ended less than 4 years ago.

Under the reporting threshold rule, businesses can make an adjustment on their next VAT return if the net value of the errors is £10,000 or less. The threshold is further increased if the net value of errors found on previous returns is between £10,000 and £50,000 but does not exceed 1% of the box 6 (net outputs) VAT return declaration figure for the return period in which the errors are discovered.

VAT errors of a net value that exceed the limits for correction on a current return or that were deliberate should be notified to HMRC using form VAT 652 (or providing the same information in letter format) and should be submitted to HMRC's VAT Error Correction team.

HMRC can also charge penalties and interest if an error is due to careless or dishonest behaviour.

Flat Rate Scheme limited cost trader check

The VAT Flat Rate Scheme has been designed to simplify the way a business accounts for VAT and in so doing reduce the administration costs of complying with the VAT legislation. The scheme is open to businesses that expect their annual taxable turnover in the next 12 months to be no more than £150,000.

A limited cost trader check was introduced in April 2017 and can increase the VAT flat rate percentage used by VAT registered businesses that use the Flat Rate scheme. Businesses that meet the definition of a 'limited cost trader' are required to use a fixed rate of 16.5%. The highest 'regular' rate is 14.5%.

A limited cost trader is defined as one whose VAT inclusive expenditure on goods is either:

  • less than 2% of their VAT inclusive turnover in a prescribed accounting period;
  • greater than 2% of their VAT inclusive turnover but less than £1,000 per annum if the prescribed accounting period is one year (if it is not one year, the figure is the relevant proportion of £1,000).

For some businesses – for example, those who purchase no goods, or who make significant purchases of goods – the outcome of the test will be self-evident. Other businesses need to complete a simple test, using information they already hold, to work out whether they need to use the higher 16.5% rate. If required to use the 16.5% rate, continuing use of the flat rate scheme will probably not be beneficial.