Just before the budget last month, HMRC announced a number of changes to the partial exemption standard method which are worthy of a comment. They apply to VAT returns for periods commencing on or after 1 April 2009.
Practical changes for existing partly exempt businesses
The first two are very practical changes and have been recommended several times over recent years. They are as follows:
• businesses can use the previous years’ recovery rate as a provisional rate rather than calculating separate quarterly recovery rates; and
• the annual adjustment can now be made in the final quarter of the VAT year, rather than the period following the final quarter.
Businesses do not have to seek permission or make any formal election to implement either of these changes. The use of the previous years’ recovery rate can be used in any year and is deemed to be in use for that year once the first return in any partial exemption year using the previous years’ recovery rate is submitted. It must then be used for all of the following returns for that partial exemption year.
These are both very welcome changes, particularly the first as it will reduce administration. The main downside is that if the businesses’ ratio of exempt to taxable supplies changes significantly during the second year, the business could find that it has significantly over or under recovered input tax during the year and have to make a single major adjustment in one go at the year end.
Businesses which have just become partly exempt
The third change applies to businesses which are newly partly exempt, ie partly exempt businesses who have just registered for VAT or businesses who have incurred exempt input tax for the first time. Rather than use the standard partial exemption method for the first year, if it does not provide a “fair and reasonable” result then businesses are able to opt to use a”use” based method.
This all sounds a bit technical but all it means in practice is that if the standard turnover based method doesn’t give a fair and reasonable result, then a business can use a different method of calculating its exempt input tax by reference to the actual use of the goods or services – a good example is a “transaction count” basis rather than a value basis.
UK businesses with overseas activities
The final change is compulsory but affects only a very limited number of businesses, so I will not go into any detail about it here. It applies to businesses which make either supplies of services to customers outside the UK; certain financial supplies such as shares and bonds and/or supplies made from establishments located outside the UK.
In the past such transactions were subject to a special partial exemption regime which required a separate calculation (known as the “Regulation 103” calculation) to calculate how much input tax could be recovered on these supplies in addition to the standard method for supplies made in the UK. The new rules mean that such input tax can now be calculated within the standard method.
The main exception to this is input tax relating to supplies of certain financial services such as shares and bonds which must be ring fenced and apportioned on the basis of use. Input tax relating to supplies of investment gold must also be dealt with separately.
See HMRC VAT Information Sheet 04/09 for further details.