Vat and Partial Exemption, the difference is important

A recent study on businesses’ knowledge of partial exemption threw up some scary findings, writes Melanie Lord. Here she dissects the issues raised

Given that my mission is to stop VAT problems from happening I talk to lots of people about how they handle their VAT and frequently encounter the same misunderstandings. One thing that I often have to correct (which really makes me feel like a complete pedant) is the difference between zero-rating and exemption. And it is an important difference.

While it matters not a jot to the man on the street whether something he buys is in one category or the other – he doesn’t pay any VAT either way – there is a world of difference for the business making the supply.



I was interested to read a recent study by Ipsos MORI exploring knowledge of partial exemption within businesses. Given that their sample of more than 5,000 organisations was biased towards larger businesses all operating within the 17 sectors typically making exempt supplies, it is rather amazing that the ratio falling into the category “Don’t know/not heard of partial exemption” ranged from 31% (financial services) to 67% (retail). (I’m ignoring here postal and courier services at 72% as they may well not be making exempt supplies so we can forgive them.)

All of this made me wonder what the percentage of “Don’t know/not heard of partial exemption” would be if the survey had used an SME sample. I suspect much, much higher and that is quite scary. I say this as I have had lots of conversations with people, including accountants, who have been incredulous to hear that exemption means the supplier can’t claim back all the VAT paid on associated purchases. Perhaps this is understandable because being exempt from something sounds like it must be a good thing. In fact VAT exemption can bring a world of pain for anyone making exempt supplies, not just in terms of costs but also increased administration in having to categorise all of the sales and purchases.

I have often had the impression that many people, again including accountants, believe that partial exemption is the domain of bigger organisations, such as those in the Ipsos MORI survey. If only it were so. The reality is that lots of small partly exempt suppliers don’t know that they ought to be jumping through a lot of hoops to arrive at their recoverable input VAT. Larger businesses often have experienced dedicated staff to look after partial exemption that is in sharp contrast to smaller organisations who often have a hard time coping with partial exemption. This includes:

  • Charities and public bodies, who may also face non-business as well as exempt apportionment.
  • Child, health and human care and social work.
  • Education and vocational training.
  • Financial services, insurance and auxiliary activities.
  • Property investment and development.
  • Membership organisations.
  • Sporting services.
  • Retail.

Perhaps retail is the most surprising to see in this list. After all there are very few physical items that you could buy from a typical retailer that could ever be exempt.

However what about a retailer selling something VATable with a valuable, separate and additional charge for insurance or finance? Retailers selling cars, furniture, electrical goods, jewellery – basically anything that’s pretty expensive – could easily be receiving exempt commissions that potentially jeopardise VAT claims on their business costs. Similarly accountants, solicitors and estate agents might often receive insurance or finance commissions leading to their entitlement to reclaim VAT on overhead costs not being guaranteed.

In a nutshell, VAT exemption is generally bad news for VAT claims for any kind of organisation. The best approach is to address partial exemption by looking at how costs are being used, find a workable accounting solution to split costs and income then run the calculations. That way, if challenged by HMRC to justify ongoing input VAT claims, they ought to avoid being caught on the back foot.

  • Melanie Lord, Director of AVS VAT

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