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Are you missing out? Annual adjustment for partly exempt businesses

11th April 2016

The VAT year-end is approaching for many businesses in the Financial Services sector.  If you don’t remember to do your annual adjustment you may be losing out on input VAT that you are entitled to have reclaimed.  

Under the partial exemption rules an annual adjustment must be carried out for each VAT year.  For most businesses (unless specifically agreed otherwise) their VAT year will end in March, April, or May depending on their VAT return periods.  

The annual adjustment uses the same partial exemption method applied to the periodic VAT returns but on an annual basis.  The input VAT actually reclaimed in the VAT returns submitted for the year is compared to the input VAT that is recoverable based on the annual calculation and an adjustment made if there is a difference between the two.  This adjustment is then included in the VAT return for that period or the next VAT return period. 

The correct application of an annual adjustment can often improve your VAT recovery position, but many businesses simply fail to carry out an annual adjustment, are unaware of the legal requirement to do so, or simply do not carry it out correctly.  

De-minimis limit

There is a de-minimis limit which allows full VAT recovery of all input VAT where the exempt input VAT is below certain limits, this applies to the annual adjustment as well. Many businesses fail to review this when the annual adjustment is calculated and could be losing out on VAT recovery. 

Standard method versus special method

It may be possible to improve the VAT recovery position by considering the use of a different partial exemption method.  Even if you have agreed a special method with HMRC, it can often be worth reviewing the application of the method and whether it is still fair and reasonable for the business, as often the method will have been agreed with HMRC some time ago after which business operations may have changed.

Capital Goods Scheme

In addition to the annual adjustment a yearly Capital Goods Scheme adjustment is required for all VAT that has been reclaimed on capital assets and this will be based on the annual adjustment.  Any commercial property (purchase and/or refurbishment) costing over £250,000 and computer hardware costing over £50,000 will be considered to be a capital asset for VAT purposes. 

What now?

Any mistakes that are made in relation to partial exemption calculation can lead to under or over recovery of input VAT.  To the extent that these errors result in over recovery, it could also lead to penalties and interest being applied by HMRC.  We would recommend that your partial exemption position is reviewed on an annual basis to ensure you are carrying out the necessary requirements correctly and are maximising your potential VAT recovery.

Our VAT team are experts in this area and can help you with your partial exemption requirements and establishing whether any improvements can be made to your VAT position. We would be pleased to arrange a free initial call with you to discuss any concerns you have in respect of your partial exemption position.

If you would like to discuss any of these issues further please contact Kamlesh Chauhan.