Andrew Needham looks at ways in which partly exempt businesses can improve their VAT position.
A business that makes a mixture of taxable and exempt supplies is known as ‘partially exempt’. Businesses that make exempt supplies are not entitled to recover the VAT on costs associated with making the exempt supplies, and so cannot recover all of the VAT that they incur.
However, there are some things that a business can do to reduce the amount of irrecoverable VAT that it incurs.
Reduce the amount of VAT incurred
There are several things that a business can do to reduce the amount of VAT that the business incurs.
From a VAT perspective, a partially exempt business should employ its own staff and not hire in temporary agency staff. VAT is charged on the supply of agency staff, and if they are used in making exempt supplies that VAT is irrecoverable.
Businesses that are part of a ‘group’ of associated companies often make intercompany charges in order to recover costs incurred by one business and used by another. If one or more of the businesses are partially exempt, there can be irrecoverable VAT on the intercompany charges.
To reduce the amount of VAT on the intercompany charges, the use of common directors can be useful. Any charges of director’s costs where they are directors of both companies are not supplies for VAT purposes, and no VAT is due on the recharges.
Similarly, the recharging of staff time between companies is a taxable supply, so staff that work for two or more companies should have joint contracts of employment. Any recharges are not considered to be supplies for VAT purposes, and no VAT is chargeable.
Forming a VAT group between two or more corporate entities under common control can also reduce the amount of irrecoverable VAT on intercompany transactions. Any supplies between members of a VAT group are disregarded for VAT purposes, and no VAT is chargeable on them.
Increase taxable supplies
The more taxable supplies a business makes, the greater proportion of VAT on overheads is recoverable. As an alternative to reducing the amount of irrecoverable VAT incurred on purchases, partially exempt businesses can also increase the value of their taxable supplies so that the proportion of irrecoverable VAT on overheads is reduced.
For example, if staff work for several companies and they cannot be VAT grouped, have the one that makes the most exempt supplies employ them, and recharge part of the cost to the others. The recharge of staff costs is a taxable supply so the proportion of taxable income increases, with a consequent increase in recoverable overhead VAT. Even if the other companies are not fully taxable, this can reduce the overall lost VAT.
If a business is involved in commercial property rental, it should consider opting to tax its properties. This converts an exempt supply of property rental into a taxable supply, and all the VAT costs associated with the opted properties becomes recoverable.
If a business is renovating empty residential property (empty more than ten years), or converting non-residential property into residential use with the intention of renting it out, the VAT is not recoverable as the rental income is exempt from VAT. If they set up an associated business to deal with the rentals and sell or long lease the properties to them, they create a zero-rated taxable supply, and VAT on the renovations/conversion is then recoverable.
Practical Tip:
If your business is partially exempt, you can improve the VAT recovery position by taking steps to reduce the amount of irrecoverable VAT incurred, or by increasing the amount of taxable supplies being made.
