What are VAT Exemptions and why do they matter?
VAT exemptions for companies are where the goods and/or services they provide are not subject to VAT. The items sold do not have VAT charged on them, so customers will buy the products at face value. This also means that the business cannot reclaim any VAT on (related) business expenses charging VAT. The type of company will depend on whether the sales are VAT exempt or VAT rated.
What is VAT?
VAT (Value Added Tax) is indirect tax that is applied to most goods and services sold for consumption in the UK, such as retails sales, food and restaurant services and professional services. Companies can charge VAT on their sales, known as output VAT, and they can reclaim VAT they have already paid on business expenses (input VAT).
Zero Rated VAT vs Exemption
A zero-rated VAT application means a 0% tax rate on any goods and services, this can allow business to reclaim VAT on related costs. However, a VAT exemption on goods and services implies that these items are outside of the VAT system, meaning although no VAT is charged, no VAT can be reclaimed on related costs.
Can my company choose whether they charge VAT on their goods and services they provide?
Typically this is outside of a corporations control and cannot choose whether their sales are VAT exempt or VAT charged. This is usually determined based on the nature of the goods and services the company provides and the taxable turnover. Currently a business must register for VAT when a Company's VAT-able turnover exceeds £90K in a rolling 12 month period. However, if a business would like, they can apply for voluntary registration even if their turnover is below the VAT threshold.
(The current VAT threshold stands at £90,000 as of 1 April 2024).
Common VAT Exempt Goods and Services
Following includes both VAT charged and VAT exempt items:
VAT Charged Goods and Services:
- Electronics
- Clothing
- Professional services
VAT Exempt Goods and Services (no VAT is charged on the sale):
- Education and training
- Insurance and financial services
- Healthcare
- Fundraising events by charitable organisations
- Memberships subscriptions
Since these exempt items lie outside the standard VAT charge, any corporation that sells only these cannot register for VAT and therefore cannot reclaim any VAT on costs.
What is a partial VAT exemption?
Some businesses can be considered partially VAT exempt companies when they provide good and/or services that both have VAT charged and are VAT exempt. In this case, they are still expected to register for VAT if the total turnover (excluding exempt items) is over the registration threshold.
When a portion of the businesses outputs (sales) are exempt, input tax cannot be automatically claimed in full. Only the portion of VAT on purchases that relate to VAT sales can be reclaimed.
How Partial Exemption Works - Under partial exemption rules:
- Input VAT directly related to taxable business sales is fully reclaimable.
- Input VAT directly related to exempt business sales is generally not recoverable.
- "Residual" input VAT (VAT incurred on expenses that relate to both taxable and exempt sales/activities) will need to be apportioned between recoverable and non-recoverable amounts using a defined method.
For example:
If a business makes both taxable and VAT exempt sales, the VAT on general expenses like rent or premises costs needs to be split between the two types of activity. The typical approach to this is the standard method by portioning out the taxable vs exempt sales.
Businesses must keep detailed records of exempt sales and how they calculate the VAT they reclaim. This includes documentation supporting the chosen partial exemption method.
Methods for Calculating Recoverable VAT
There are different ways of calculating how much VAT your company can reclaim. By UK law, businesses with a partial exemption must use an approved method to calculate the amount of VAT they can recover.
Here is a brief overview of the two main methods:
1. Standard Method
This is the most common method used by partially exempt businesses. It calculates the portion of residual input tax reclaimable by the amount of taxable sales compared to total sales in the accounting period. This usually offers a fair and reasonable basis for apportioning VAT recovery.
2. Special Methods
In some cases, the standard method may not accurately reflect how costs are used in the business. In this case a business will need to request a special method authorised by HMRC that better matches the businesses status. To be accepted, the method must be fair and reasonable and reflect the actual use of expenses. HMRC approval is required to start or stop using a special method.
Special methods typically involve a more detailed analysis of how certain expenses contribute to taxable versus exempt activities (sales).
Land and Buildings
Property assets that are typically exempt from VAT:
If a company lets or leases commercial property that would normally be exempt, it can elect to opt to tax the property and "waive the exemption". This means VAT is charged on the rent and related supplies become taxable for VAT purposes, enabling input VAT on associated costs to be reclaimed.
Capital Goods Scheme
For large capital assets (such as high-cost equipment or company property), VAT recovered initially can instead be adjusted over several years if the use of the asset changes from taxable to exempt activities (over the years of having the asset). This will ensure VAT recovery reflects the actual use of the asset over time.
This scheme applies if your business spends (net of VAT):
- £250,000 or more on land or buildings, or civil engineering works.
- £50,000 or more on a single piece of computer equipment (e.g. a single computer).
- £50,000 or more on an aircraft, ship, boat or any other vessel.
Over the next 5 or 10 years (dependant on the asset type) the company would need to review how the asset is actually used each year, if this scheme is used. You can reclaim more if the proportion of taxable sales increases, or you may need to repay any if the proportion decreases.
Remaining Compliant
If your business is partially exempt from VAT, then it would be best to keep records of the following:
- A full breakdown of sales that are (VAT) taxable vs exempt sales.
- Details of input tax on expenses and how these relate to different types of sales
- Records of the partial exemption method used and any approvals from HMRC
Keeping these types of records are essential for accurate VAT reporting!
