For many businesses, exempt income is not something they think about when completing a VAT return.
Example 1: Retail businessA retail business may have rental income from a flat above the shop, but this may only make up a small proportion of turnover and the expenditure associated with it may also be minimal. VAT rules allow for VAT to be reclaimed in connection with expenditure that generates exempt income, where this VAT is less than £625 per month and less than 50% of the total VAT on expenses in the period. Providing these de minimis limits are not exceeded, VAT recovery is not restricted and there is no impact on the business’ VAT return figures. |
However, what happens when there is a change in circumstances such as the national lockdown in response to COVID 19? One consequence could be exempt income becoming the predominant income source for a business.
Example 2: Property rental exampleA landlord with a property consisting of both commercial premises and dwellings (e.g., flats) will charge VAT on the rental income from the commercial premises if there is an option to tax in place. However, the rental income from the flats will be exempt. A rental holiday for the lessees of the commercial premises forced to close in lockdown could result in all the landlord’s income being exempt from VAT. This could lead to a situation where any VAT incurred on expenditure is not reclaimable as it is not generating any taxable income. If the landlord is receiving a reduced income from commercial rent, the reclaimable VAT could still be restricted as the standard method of determining how much VAT on expenditure can be reclaimed is based on taxable income as a percentage of total income. |
Examples of exempt income which may affect the amount of VAT you can reclaim are:
- Sale of lottery/raffle tickets
- Retailer lottery commission
- Property rental income (residential property and commercial property with no option to tax)
- Lease of land (if no option to tax)
Businesses with both taxable and exempt income
A business with both taxable and exempt income is required to carry out a partial exemption calculation when completing the quarterly VAT return and an annual adjustment at the partial exemption year end (i.e., the end of March, April or May depending on VAT return periods).
The calculation requires VAT on expenditure to be split between purchases/expenses used to generate taxable income, those used to generate exempt income and those relating to the business as a whole, e.g., IT expenses, utility bills, stationery.
Review your VAT return calculations
If your business receives exempt income and you are not carrying out a partial exemption calculation, it is advisable to review your VAT return calculations for past periods especially in the periods where the value of your taxable income has fallen, or exempt income has increased.
Shorts have an experienced VAT team should you have any questions or require assistance with partial exemption issues.
Lynne Gill
My area of expertise is land and property transactions but I have extensive knowledge of both domestic and international VAT and I love complex VAT queries. I have an Honours degree in Business Studies and a VAT legal and technical qualification from the Institute of Indirect Taxation.
View my articlesTags: VAT
