Partial Exemption Special Methods

Introduction

If your business makes both VAT-exempt and VAT-taxable supplies, you'll need to use a partial exemption method to work out how much VAT you can reclaim on overheads. The standard method doesn't always produce a fair result, particularly for businesses with complex operations. In these cases, you can apply to HMRC for a Partial Exemption Special Method (PESM) that better reflects how your business actually uses goods and services.

What is a Partial Exemption Special Method?

A Partial Exemption Special Method is an alternative way of calculating how much input VAT (the VAT you pay on purchases and expenses) you can recover when your business makes both taxable and exempt supplies.

The standard partial exemption method allocates recoverable VAT based on the proportion of taxable supplies to total supplies. However, this can produce unfair results if your costs don't split in the same way as your income. A special method allows you to calculate VAT recovery in a way that more accurately reflects how you use goods and services in your business.

When to consider applying for a special method

You should consider applying for a PESM if:

• The standard method produces a result that doesn't fairly represent the actual use of goods and services in your business
• You have overhead costs that relate more to one type of supply than the standard calculation suggests
• Your business operates in a sector where complex partial exemption issues are common
• You want certainty about how to calculate your VAT recovery going forward

A special method must produce a fairer and more reasonable result than the standard method. It should reflect the actual use or intended use of goods and services in making taxable supplies versus exempt supplies.

Partial exemption frameworks for specific sectors

HMRC has developed partial exemption frameworks for certain sectors where partial exemption issues are particularly complex. These frameworks are created jointly with sector representative bodies and provide agreed approaches that HMRC will accept.

Frameworks currently exist for:

• Insurance sector
• Housing associations
• Higher education institutions (HEIs)
• NHS bodies
• Government departments

If your business operates in one of these sectors, you should consult the relevant framework before preparing your application. The frameworks explain when and why special methods are needed in your sector and set out approaches that HMRC considers fair and consistent. Using a framework approach can significantly reduce the time and cost involved in getting approval.

What documents you need to provide

Your application must include several documents:

• A proposal document – explaining your proposed method and why it's fairer than the standard method
• A worked example – showing how your proposal would work in practice using real figures
• Your latest annual adjustment calculation – demonstrating the current position under the standard method
• A declaration – check Appendix 1 of VAT Notice 706 for what to include
• Any additional supporting documents – such as detailed cost analyses or business structure information

Full details about the documents required are set out in Appendix 2 of VAT Notice 706.

Your proposal should clearly explain the methodology, demonstrate why it's fairer than the standard method, and show that it produces a reasonable result.

How to apply

You apply online through HMRC's digital service. You can sign in using:

• Your existing Government Gateway sign-in details (you can create these if you don't already have them)
• Your email address to receive a confirmation code

The online application allows you to upload the required documents as part of your submission.

HMRC's response timescale

HMRC will contact you within 30 days of receiving your application to tell you one of three things:

• They accept your proposal
• They need more information before making a decision
• Your proposal is not suitable, with reasons why

If HMRC requests more information, you'll need to provide this before they can make a final decision. The 30-day clock applies to the initial response, not necessarily final approval.

Important points to remember

Once approved, you must use your special method consistently. You'll need to apply it to your partial exemption calculations going forward and cannot simply switch back to the standard method without HMRC agreement.

You should review your special method regularly to ensure it continues to produce a fair result. If your business structure or activities change significantly, your approved method may no longer be appropriate, and you may need to apply for a revised method.

Keep detailed records of how you apply your special method. HMRC may review this during a compliance visit, and you'll need to demonstrate that you're applying the approved methodology correctly.

Sources

• Apply for a Partial Exemption Special Method
• Partial Exemption Frameworks

This article provides general guidance based on current HMRC rules. For advice specific to your situation, speak to your accountant.