VAT partial exemption simplification update

Simplification

In July 2019, the Government launched a call for evidence on the simplification of the VAT partial exemption and Capital Goods Scheme regimes. Many Financial Services businesses were hoping that this would result in simplification of a very complex area of compliance – unfortunately, the outcome announced on the inaugural ’Tax Day’ on 23 March 2021 was somewhat underwhelming! The Government has announced it is setting up a central point to submit applications for partial exemption special methods as well as an application form, but whilst these changes may increase the efficiency with which applications are logged by HMRC, they seem unlikely to increase the speed at which applications are processed and approved.

HMRC is reviewing sectoral frameworks within which such methods may be set and has said it will consider increases to the partial exemption de minimis limit and the threshold at which items fall within the Capital Goods Scheme.

Given that simplification of these provisions was a key recommendation of the Office for Tax Simplification, this is quite a disappointing outcome for the Financial Services sector, which is one of the biggest sectors affected by partial exemption.

Annual adjustment and temporary measures for COVID-19

Unless otherwise agreed in writing by HMRC, the VAT year end for partial exemption purposes ends in the March, April or May VAT return periods. An annual adjustment calculation will need to be carried out following the year end.

On 23 March 2021, HMRC also published a Revenue & Customs Brief acknowledging the impact COVID-19 may have had on VAT recovery rates. The Brief states that HMRC will allow organisations to request temporary changes to their partial exemption method to reflect changes to their business practices as a result of COVID-19. For Financial Services businesses about to carry out their annual adjustments, this could be an ideal time to consider this potential opportunity.

For those using the standard method, HMRC indicates that the standard method override may apply, and for organisations using special methods it advises that it may accept a request to use a method based on figures from the prior year which are more reflective of the normal trading patterns. This could be beneficial for many businesses that have reduced taxable income in the last year.

Amendments to methods will be time-limited with a default limit of one year. Most importantly, HMRC states that it will only allow a change to a method which is requested after the end of the tax year in exceptional circumstances.

The tax year of an organisation is the return period ending March, April or May depending on its return stagger. That means that organisations with calendar quarter VAT returns had until 31 March to request an amendment to their partial exemption methods. Given that this Brief was only issued on 23 March, one must hope that the late issue of this guidance is accepted by HMRC as an ’exceptional’ circumstance for businesses provided that they write to HMRC immediately following their year end.

Partly exempt businesses who have seen their recovery rates drop due to COVID-19 are strongly encouraged to seek advice as to whether they could benefit from this announcement as soon as possible.

Any improvements in the annual adjustment recovery rate would also have a knock-on effect for any Financial Services businesses with assets still within the Capital Goods Scheme. A similar accelerated process will apply to Capital Goods Scheme adjustments and HMRC has also said that where planned events have had to be cancelled that an adjustment to the value of the supply would normally arise in an income-based calculation to reflect refunds. HMRC has indicated that requests not to make an adjustment on this basis will be considered sympathetically, so it is something that should be considered for businesses that have had to issue refunds due to COVID-19.