PE3050 - Partial Exemption Special Methods: Consideration, approval and refusal of a special method
When considering whether a method is fair and reasonable, you should focus on how the costs on which the input tax is incurred are used, rather than the input tax itself:
- Is it realistic that this proportion of the costs is ascribed to these supplies?
- Do the accounts of the business treat the costs in the same way as the PE method?
- Does the partial exemption method imply that the cost of making a supply is greater than its value?
There may be good reasons for all these, but equally it may be that the method does not apportion the costs appropriately.
You should bear in mind that it is possible that some businesses and advisors may approach proposals with an intention to maximise recovery rather than reflect the use of the input tax bearing costs in making taxable supplies. They may choose the method giving highest recovery (often with the aid of computer modelling software, which may not use the actual figures accounted for by the business in the relevant periods), and present arguments as to why this gives a fair and reasonable result. It is therefore worth asking whether the business, or their advisors, have considered any other special methods, what the result of those methods would be, and why the method proposed was chosen instead of the alternatives.
Decisions on the acceptability, or otherwise, of a special method for a particular business will always be difficult. You need to be satisfied that the proposal reflects the use of the goods and services to make taxable supplies. Every case needs to be considered on the basis of all the available information; do not assume that a method that has been approved for an apparently similar business will automatically give a fair and reasonable result for your business. There may be small but significant differences between the two businesses’ mix of supplies or the way they operate. Alternatively the person who approved the method for the other business could have overlooked something relevant. As partial exemption is all about determining how much of a business’s input tax is incurred in making taxable supplies, it follows that you need to identify all the business’s activities. You will also need to consider intended activities to the extent that they are known to the business.
It is expected that a specialist partial exemption resource, such as a PESO or other TAPE team officer will be involved in the preparation of a partial exemption method. This is because partial exemption is a complex area and there are often significant amounts of tax to be addressed. It is very important, for example, to use terms in the approval letter that are legally certain and to ensure that the method is capable of dealing with possible changes in the way the business operates. Specialist resources will be able to advise on current Departmental policy and best practice along with any relevant case law that may affect your business. In any case, you should always notify your local TAPE team if you receive an application for a special method. This will enable the details of the method application to be recorded so that they are available for risk and assurance purposes. It also enables the time taken to approve or reject the method to be monitored; which is a measure of our customer service.
All approvals of special methods must now be in writing. Since partial exemption special method approval letters are among the most important letters that are sent to businesses, it is vital that they are carefully checked before issue for typing errors, ambiguous statements and imprecise definitions. As noted above, the intention and operation of the method may be compromised if statements are capable of being interpreted in different ways or are otherwise unclear as to their meaning.
A special method request should always be refused if:
- it does not reflect the use of the input tax bearing costs; or
- visiting officers cannot readily check its accuracy, this includes audit officers being refused access to the program that will run the method; and
- it does not deal with all the input tax incurred by the taxpayer.
Any refusal to approve a method may be appealed to the Tribunal under section 83(e) VATA 94, so it is important that full reasons are given to the business as to why approval has not been given. A letter should be sent, setting out in full detail:
- HMRC’s concerns as to why the method would not give a fair and reasonable result; and
- confirmation that the proposal has been rejected, but inviting further proposals that address those concerns.
It may also be helpful to set out the Commissioners understanding of the operation of the proposed method, requesting confirmation that it is correct, in case their interpretation is different. Any ambiguities can then be addressed.
Following refusal of a method, businesses will often ask the Officer to come up with a method that is fair and reasonable. This is not the role of HMRC. It is for the business to propose a method, and the Commissioners to approve or reject a method. However, the officer should be as helpful as practical to the business and where possible, should indicate the types of method that would be likely to receive approval.