Back to basics: Partial Exemption for TPS

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By Anne-Marie Roberts, ICAS Tax Programmes Manager

25 February 2019

Do you know how to allocate residual input tax for a business? We get back to basics on calculating partial exemption for TPS level.

What is partial exemption?

Input tax can be recovered by a VAT-registered business if it relates to goods and services with a “direct and immediate” link with taxable supplies made by the business. A business which makes both taxable and exempt supplies is a partially exempt business and it will need to allocate input tax to supplies of goods and services to determine the amount it is able to recover through the VAT return.

How to allocate input tax

Under the VAT regulations (SI 1995/2518 regulations 99 - 111), a business is required to allocate input tax into three types:

  • Input tax incurred exclusively in making taxable supplies
  • Input tax incurred exclusively in making exempt supplies
  • Input tax incurred in making both taxable and exempt supplies – this is known as residual input tax. This will include the overhead costs of the business such as heat, light, power, rent and audit fees.

These rules affect all VAT-registered businesses but have no impact on businesses which are fully taxable as all input tax is allocated to taxable supplies.

Input tax incurred exclusively in making taxable supplies can be recovered in full. Input tax incurred exclusively in making exempt supplies cannot be recovered. Residual input tax must be allocated between taxable and exempt supplies, and the partial exemption calculation is the mechanism for calculating this split.

Illustration of allocation

For example, ABC Ltd is a partially exempt company. In the quarter to 31 March 2018, its taxable turnover is £100,000 and exempt turnover is £60,000. It has incurred input tax as follows:

  • Input tax incurred exclusively in relation to taxable supplies - £15,000
  • Input tax incurred exclusively in relation to exempt supplies - £3,000
  • Residual input tax incurred - £5,000

The £15,000 can be recovered in full, whilst the £3,000 is irrecoverable VAT and a cost to the business. The business must allocate the residual amount of £5,000 into taxable and exempt amounts.

The standard method allocates the residual VAT using regulation 101 of SI 1995/2518. The formula is:


FormulaFor this example:
Taxable supplies / Taxable + exempt supplies =£100,000 / £160,000 = (62.5% rounded up) 63%

The 63% is then applied to the residual input tax, to calculate the element of residual input tax that can be treated as taxable input tax: £5,000 x 63% = £3,150.

The business can recover input tax of £15,000 (incurred exclusively to make taxable supplies) and £3,150 (residual input tax) to give a total recovery of £18,150 for the quarter.

The exempt input tax of £4,850 (incurred exclusively to make exempt supplies of £3,000 and £1,850 residual input tax) cannot be recovered.

Impact of de minimis rules

Once the direct attribution and any apportionment have been done, it is possible to ignore a small amount of irrecoverable input tax under Reg 106. To fall within this rule, the irrecoverable input tax must be:

  • no more than £625 per month on average (£1,875 a quarter or £7,500 a year); and
  • no more than half of the total input tax in the period.

You will see that in this example, the amount of exempt input tax exceeds these limits (£4,850 exempt input tax), so the business will only be able to recover £18,150 of the £23,000 input tax incurred.

Conclusion

The partial exemption calculation applies to businesses which have both taxable and exempt supplies to allow the allocation of input tax including “residual input tax” – this can include input tax incurred on general business overheads which cannot be directly attributed.

The calculation of input tax recoverable is generally based on the turnover of the business applying the rules outlined in SI 1995/2518 regulations 99 – 111. Any input tax which cannot be recovered is a cost to the business.

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