Partial Exemption

More and more farming operations are experiencing the impact of partial exemption on their VAT accounting as they diversify away from farming activities and move into areas where they let cottages, land and buildings. Although in most cases these rentals will be VAT exempt i.e. no VAT is chargeable on the income received, the activities can lead to difficulties with recovering VAT on the associated costs.

The general premise here is that while the VAT incurred on costs directly associated with taxable business activities (i.e. the farm sales made at the zero rated, reduced rate or standard rate of VAT) can be claimed as input tax through the farm’s VAT returns any VAT incurred on costs which are attributable to the exempt supplies (rent) can only be recovered where its value falls below certain limits. These are the partial exemption de minimis limits where in most cases the VAT on the costs associated with the exempt activities has to fall below both £625 per month on average and 50% of the total input tax claim for it to be recoverable from HMRC.

These provisions place an onus on the farm to correctly identify the VAT treatment of the sales it makes and then carry out an exercise under which the VAT incurred on the associated expenditure is attributed to the taxable and the exempt sales. This is the basis of a partial exemption calculation that needs to be carried out for each VAT accounting period and then again for each VAT year to calculate whether all of the VAT incurred can be claimed from HMRC. A VAT year will end at 31 March, 30 April or 31 May each year depending on the dates of the VAT returns and if any adjustment is required to the claims made on the previous returns it has to be taken into account, at the latest, by the submission of the first return for the next VAT year.

The provisions are not particularly straightforward and do carry an exposure to penalties and interest charges where the rules are incorrectly applied. However they also to provide an opportunity for some VAT planning through by considering the impact of VAT on a particular project. For example under the de minimis limits spending a VAT exclusive figure of £50,000 on the standard rated refurbishment of a cottage for residential letting in one VAT year would mean that the £625 limit above is exceeded with the effect that £10,000 in VAT incurred would be irrecoverable. In some cases it may be possible to spread the cost over two VAT years to take advantage of two years worth of de minimis limits. In other cases it may be possible to look at the liability of the building work – if the work qualified for the 5% reduced rate it could mean that the VAT involved falls within the de minimis limits anyway. In addition where you have commercial let property you can elect to opt to tax these which results in VAT being chargeable on the rent (which hopefully your VAT registered tenant can reclaim) but allows you to reclaim VAT on the associated costs. Advice should be taken before opting any property as there are long term implications of this.

The main point to note is that it is always better to consider the VAT recovery position at the outset of a project rather than having to make an adjustment to the VAT claimed later on.

If you require any further assistance or would like more information then please get in touch with Andy Branson.

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