Noelia Serrano & Ross Palmer September 2016 VAT returns and partial exemption

Background VAT recovery Annual adjustment Methods VAT in accounting system Completing the VAT return Other issues Agenda 2

Background: Types of supply Non-business (or outside the scope of VAT) Business supply Exempt supplyTaxable supply Zero rated supply Reduced rate supply Standard rated supply 3

Type of supplyCharge output VAT?Recover VAT on purchases incurred in making the supply? Non-businessNoNo (unless hospice, academy etc..) Business ExemptNoNo, unless exempt activity is “de-minimis” Taxable Standard-rated (default) 20%Yes Reduced rate5%Yes Zero-rate0%Yes Background: Types of supply 4

Outside the scope of VAT Funded wholly by grants or donations Subsidised welfare activities (charge less than 85% of cost) Subsidised fees in particular situations (nurseries etc) Background: Non-business activities 5

Welfare Residential care Nurseries Training activities Medical care Education Background: Exempt supplies Cultural activities Fundraising events Renting land & buildings Lotteries and bingo 6

Sale of donated goods by a charity Export of goods by a charity Sale of printed publications - books, newsletters etc Sale of children’s clothing & footwear Some passenger transport Some food and drink Background: Zero-rated supplies 7

Welfare information and advice (that does not qualify for zero-rating) e.g. DVDs Fuel and power for domestic or charity non-business use Smoking cessation products Contraceptives Children’s car seats Background: Reduced rate supplies 8

Everything else! Consultancy fees Information supplied electronically eg: pay access websites Management charge to trading subsidiary Royalties Background: Standard-rated supplies 9

Recovering VAT = deducting VAT incurred on purchases (input VAT) from VAT on sales payable to HMRC (output VAT) Input VAT is recoverable if the associated purchase: Is used in making taxable supplies or Is used in making exempt supplies, and total exempt activity is de-minimis VAT recovery: Meaning 10

SupplySales are:VAT on design services is: Charity A produces and sells a printed report. It incurs cost of £1,000+VAT for design and layout services. Zero-ratedRecoverable in full Charity B produces and sells an electronic report via its website. It incurs cost of £1,000+VAT for design and layout services. Standard- rated Recoverable in full Charity C produces a report which it distributes for free via its website. It incurs cost of £1,000+VAT for design and layout services. Non- business Not recoverable VAT recovery: Example 11

VAT on some types of purchase is always irrecoverable – whatever type of activity the purchase is used for: The purchase of cars available for private use VAT on business entertaining, e.g. taking business customers out for meals. But excludes staff meals and meals for beneficiaries (e.g. in a care home) VAT recovery: Blocked input VAT 12

VAT which is not wholly used in making one type of supply is called “residual VAT” Types of supply are non-business, exempt and taxable Examples of residual VAT: for charities with a mix of non-business, exempt and taxable activities, overheads are usually residual e.g. gas and electricity bills, audit fee, telephone charges, premises costs for a shared use building VAT recovery: Residual VAT 13

1.Direct attribution 2.Business/non-business method 3.Partial exemption method 4.De-minimis test 5.Annual adjustment VAT recovery: Steps 14

Directly attributable to:Recoverable? Taxable suppliesYes Exempt suppliesOnly if de-minimis – go to step 4 Non-business activitiesNo Cannot be directly attributed to one type Go to step 2 VAT recovery: 1. Direct attribution VAT on purchases used wholly in one type of activity is directly attributed to that activity type 15

In step 2, residual VAT must be apportioned between business and non-business activities Business activities = taxable activities + exempt activities If there are no non-business activities – skip step 2- all residual VAT goes into step 3 This apportionment is known as the “business / non- business method” The residual VAT apportioned to non-business activities is irrecoverable The residual VAT apportioned to business activities goes into step 3 VAT recovery: 2. Non-business method 16

In step 3, the residual VAT apportioned to business activities must next be apportioned between taxable and exempt activities. This apportionment is known as the “partial exemption method” If there are no exempt activities, skip steps 3 and 4 - all residual VAT apportioned to business activities in step 2 is recoverable. The residual VAT apportioned to taxable activities is recoverable The residual VAT apportioned to exempt activities must go into the de-minimis test (step 4) to see if it is recoverable or not VAT recovery: 3. Partial exemption method 17

The total “exempt VAT” is: The VAT which is directly attributed to exempt activities (step 1), plus The residual VAT apportioned to exempt activities (step 3) If this exempt VAT passes any of the de-minimis tests it is recoverable in full If not, it is irrecoverable Since April 2010 there are two new tests to use before the old test VAT recovery: 4. De-minimis test 18

Test One: If business VAT is: Less than £1,875 in a VAT quarter and The value of exempt supplies is no more than 50% of the value of all supplies Then the exempt VAT is recoverable Test Two: If business VAT less VAT directly attributable to taxable supplies is: Less than £1,875 in a VAT quarter and The value of exempt supplies is no more than 50% of the value of all supplies Then the exempt VAT is recoverable VAT recovery: 4. De-minimis test 19

Test Three (the old test): If this exempt VAT is: Less than £1,875 in a VAT quarter and Less than 50% of the total VAT attributed to business activities in the VAT quarter Then the exempt VAT is recoverable If none of the three tests work, the exempt VAT is irrecoverable VAT recovery: 4. De-minimis test 20

VAT recovery: Flow chart Balance that cannot be directly attributed is residual VAT Step 2 Business/non-business method: apportion residual VAT between business and non-business Directly attribute to Non-business activities Business Residual VAT Non-business Residual VAT Step 3 Partial exemption method: apportion business residual VAT between taxable and exempt IrrecoverableRecoverableStep 4: Recoverable if de-minimis Exempt residual VAT Directly attribute to Exempt activities Directly attribute to Taxable activities Taxable residual VAT Step 1 directly attribute VAT on purchases as far as possible 21

At the end of the VAT year: Repeat steps 1 – 4, using figures for the whole VAT year (all four VAT quarters added together) Use de-minimis limit of £7,500 Any difference from the VAT actually recovered in quarters 1 to 4 must be adjusted for in the first VAT return on the next VAT year or final of current year Note that this adjustment is not an error Annual adjustment 22

Can use any business/non-business method provided it produces a result that is fair and reasonable. Fair and reasonable means the apportionment accurately reflects actual use of the associated purchases. There is no need to obtain prior approval of the method from HMRC. Methods: Business/non-business 23

Methods: “Standard” B/NB method Percentage of residual VAT apportioned to business activity (%) = Net turnover on business supplies (B) x100% Net turnover on business supplies (B) + turnover on non- business activities (NB) Residual VAT apportioned to business activity (£) = Percentage of residual VAT apportioned to business activity (%) x VAT on residual purchases (£) 24

VAT incurred in generating unrestricted donations What matters is how those donations are used: Used to support the general (residual) activities of the charity, the VAT on the fundraising costs is residual Wholly used to subsidise taxable supplies – the VAT is recoverable in full Wholly used to subsidise exempt supplies – the VAT is irrecoverable (unless exempt input VAT is de-minimis) Wholly used to subsidise non-business activities such as grant funded activities – the VAT is irrecoverable A recent Tax Tribunal case suggests the Children’s Society treatment also applies to investment management costs Methods: Children’s Society 25

Passive income = negligible VAT bearing residual costs incurred to generate Omit passive non-business income from the standard business / non-business method E.g. (possibly) bank interest, legacies etc Methods: Passive income 26

A business must use the standard partial exemption method unless it agrees a different method (a special partial exemption method) with HMRC. From 1 April 2007 new (or changed) special partial exemption methods must be approved in writing with a declaration that the method is fair and reasonable. Methods: Partial exemption method 27

Percentage of residual VAT apportioned to taxable activity (%) = Net turnover on taxable supplies (£) x100% Net turnover on taxable supplies (£) + turnover on exempt supplies (£) Methods: Standard PE Method Residual VAT apportioned to taxable activity (£) = Percentage of residual VAT apportioned to taxable activity (%) x Residual VAT apportioned to business activity (£) The percentage of residual VAT apportioned to taxable activity is rounded up to the nearest whole percent. 28

Exclude from turnover figures: Incidental one off transactions e.g. sale of fixed assets Supplies from foreign branches (must have their own separate calculation) From 1 April 2009 can use previous annual adjustment percentage on a provisional basis throughout year Methods: Standard PE Method 29

Staff FTE Staff time Staff cost Floor area Directly attributable expenditure Methods: Special PE methods 30

From 1 Jan 2011 can apply to HMRC for a combined method – combines the B/NB & PE methods into one calculation Advantage – no need to distinguish between VAT attributable to exempt and non-business activities Disadvantage – there is no de-minimis allowance Combined methods 31

Most common approach is VAT codes Every transaction is assigned a VAT code This code determines how the transaction is dealt with for VAT purposes Accounting systems: VAT codes 32

CodeDescriptionRateInclude T0Income - zero rated0%Y T1Income – standard-rated20%Y T2Income – exempt0%Y T3Income – non-business active0%Y T4Income – non-business passive0%Y T5Purchases – Std rated – used for taxable supplies20%Y T6Purchases – Std rated – used for exempt supplies20%Y T7Purchases – Std rated – used for non-business activities20%Y T8Purchases – Std rated – used for residual activities20%Y T9Do not include in VAT reports0%N T10Purchases – reduced rated – used for residual activities5%Y Accounting systems: Sage example 33

Periodically (usually quarterly) need to report: VAT charged to customers in the period VAT on purchases in the period that is recoverable The net values of sales and purchases in the period Certain details about cross-border supplies VAT return 34

Normally transactions reported on accruals basis Under cash accounting scheme transactions reported on paid/received basis Automatic bad debt relief Taxable turnover must be below £1.35m No need to apply to HMRC – unless owe HMRC money, convicted of an offence, penalised for dishonesty etc. VAT return: Cash accounting 35

Only one annual VAT return submitted But must still pay over estimated liability in instalments on a regular basis Taxable turnover must be below £1.35m Must apply to HMRC to join VAT return: Annual accounting 36

BoxDescription 1VAT due on sales and other outputs 2VAT due on acquisitions from other EU countries 3Total VAT due 4VAT reclaimable on your purchases 5VAT payable or reclaimable 6Total sales excluding VAT 7Total purchases excluding VAT 8Total value of goods you supplied to other EU countries 9Total value of goods you acquired from other EU countries VAT return: Boxes 37

Can recover VAT on pre-registration goods (eg stock) provided: Still on hand at registration Not purchased more than 4 years before But HMRC expect apportionment if used before registration Can recover VAT on pre-registration services provided: Attributable to a taxable supply made after registration Supplied not more than 6 months before Pre-registration VAT 38

Can adjust in next VAT return if: 1.The net value of the error is less than the greater of £10,000 and 1% of the figure entered in box 6 of the VAT return, subject to an overall limit of £50,000 2.The error does not relate to supplies or purchases in a VAT period ending more than 4 years ago If error above limits in (1) must disclose details to HMRC Errors 39

Various schemes that refund VAT incurred in non-business activities: ‘s33b’ for academy and free schools ‘s33c/d’ for hospices, search and rescue charities and medical courier charities (from 1 April 2015) VAT directly attributed and apportioned to non-business activities can be claimed VAT refund schemes 40

If VAT registered add to box 4 If not VAT registered, claim via form VAT 126 (download from gov.uk) Must use separate business / non-business apportionment Cannot use a combined method as need to distinguish between non-business VAT and exempt VAT VAT refund schemes 41

Need to adjust initial VAT recovery on expensive assets (usually land & buildings costing >£250k) used for mixed taxable & exempt or non-business activities Adjust over first 5/10 years of use Adjust for changes in percentage of taxable use Adjustment made in annual adjustment Changes to scheme on 1 Jan 2011: Inclusion of non-business use in the scheme Inclusion of boats and aircraft costing £50,000 or more Changes to refurbishment and alteration works Capital goods scheme 42

Can only recover UK VAT in the UK VAT return Foreign VAT must be recovered directly from the foreign tax authorities Claim EU VAT via HMRC website VAT must be recoverable under that country’s VAT rules Foreign VAT 43

Where buy goods or services from abroad or Where sell goods or services to a foreign customer Rules depend on: Whether goods or services Status of customer Location of customer (in EU or outside EU) For services, the type of service Cross border supplies 44

VAT made simple VAT notice 701/1 Charities Contact details 45