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New VAT Partial Exemption Rules

Newsletter issue - May 2010.

Some VAT registered businesses make sales that are exempt from VAT as well as sales that are subject to VAT at the standard, lower or zero rate. For example, estate agents receive commission on selling houses (VAT at standard rate), and commission on selling financial products (exempt from VAT). Such businesses are referred to as partially exempt as they can only reclaim the VAT on that part of their purchases (input VAT) which relates to the VAT-bearing sales.

Working out how much VAT such a partially exempt business can reclaim can be complex, particularly if the VAT-exempt sales are a small part of the whole business. In this case the VATman does allow the business to reclaim all of their input VAT if it can pass one of three tests (called the de-minimis tests). Before 1 April 2010 there was only one test:

The input VAT relating to exempt sales is less than:

  • £625 per month on average; and
  • 50% of the total input tax.

For VAT periods starting on and after 1 April 2010 there are two additional optional tests. If the business can answer 'yes' to both parts of either test 1 or test 2, the business passes the de-minimis test, and can reclaim all its VAT for the quarter. However, it must also check the figures for the full year.

Test 1

  • Is the total input tax less than £625 per month on average; and
  • Is the exempt income less than 50% of the total sales?

Test 2

  • Is the total input VAT less input VAT directly attributable to VATable sales less than £625 per month on average; and
  • Is the exempt income less than 50% of the total sales?

Once the business has passed the de-minimis test for a year, the VATman will assume the business will pass the test for the next year, so it can reclaim all its VAT for coming quarters. However, at the end of the year it must check it has passed the de-minimis test for the full year.

Please contact us for advice in this complex area.

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