Exempt and partially-exempt businesses for VAT purposes

Some goods and services are exempt from VAT, such as insurance and finance, education and training, and charitable fund-raising events.

If all of the goods and services you sell are exempt, your business is exempt and you won't be able to register for VAT. This means you won't be able to reclaim any VAT on your business purchases.

If you are VAT-registered and incur any input tax that will be used to make exempt supplies, you are classed as partly exempt. This guide provides information on exempt and partly exempt businesses. It shows you what you need to do to reclaim VAT if your business is partly exempt.

On this page:

Exempt and partly exempt businesses explained

Exempt goods and services

There are some goods and services on which VAT is not charged. These are exempt from VAT. Items that are exempt from VAT include the following:

  • insurance, finance and credit
  • education and training
  • fund raising events by charities
  • subscriptions to membership organisations
  • selling, leasing and letting of commercial land and buildings - but this exemption can be waived

Exempt supplies are not taxable for VAT. So you do not include sales of exempt goods or services in your taxable turnover for VAT purposes. If you buy exempt items, there is no VAT to reclaim.

This is different to zero-rated supplies. In both cases VAT is not added to the selling price, but zero-rated goods or services are taxable for VAT - at 0 per cent.

Find out what goods and services are exempt from VAT

If you only sell or supply exempt goods or services

If you only sell or otherwise supply goods or services that are exempt from VAT then your business is an exempt business and:

  • you cannot register for VAT
  • you cannot recover any VAT you incur on your purchases or expenses

This is in contrast to the situation if you sell or otherwise supply zero-rated goods or services, where you can reclaim the VAT on any purchases that relate to those sales. In addition, if you sell mainly or only zero-rated items, you may apply for an exemption from VAT registration, but then you can't claim back your input tax.

Find out more about registering for VAT and VAT thresholds

Get details about the different VAT rates

Find out what goods and services are exempt from VAT

If you are registered for VAT but make some exempt supplies

Your business is partly exempt if your business has incurred VAT on purchases that relate to exempt supplies. This is known as exempt input tax.

Generally, you won't be able to reclaim exempt input tax. However, provided the amount of exempt input tax is below a certain amount, it can be recovered in full.

See the sections in this guide on reclaiming VAT in a partly exempt business.

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Reclaiming VAT in a partly exempt business

If your business is partly exempt, and you want to reclaim input tax - the VAT you incur on purchases that relate to your business activities - you must make two calculations each time you complete your VAT Return. You add the results of these two calculations together - this is the amount of input tax you can reclaim.

These calculations are based on the use you make or intend to make of your purchases - whether that use is:

  • entirely for the taxable supplies you make
  • entirely for the exempt supplies you make
  • partly for the taxable supplies you make and partly for the exempt supplies you make

If the amount of VAT incurred relating to exempt supplies is below a certain amount, the VAT can be recovered in full. See the section in this guide on calculations to reclaim VAT.

Once a year - usually at the end of your VAT tax year - you must review how much VAT you've reclaimed throughout the year and make an annual adjustment. See the section in this guide on making your annual adjustments.

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Calculations to reclaim VAT

Step 1: all or nothing

Each time you complete a VAT Return you need to look at all of your business purchases to identify:

  • the items that relate entirely to your taxable supplies
  • the items that relate entirely to your exempt supplies

You can generally reclaim all the input tax you've paid on purchases that relate entirely to your taxable supplies, but none of the input tax on your purchases that relate entirely to exempt supplies.

Step 2: mixed use

Next you'll need to identify your business purchases that relate both to your taxable supplies and to your exempt supplies - for example, phone bills or accountancy fees.

You'll only be able to reclaim the input tax on the proportion that relates to your taxable supplies.

You can work out the percentage you can reclaim in one of two ways:

  • HM Revenue & Customs’ (HMRC's) standard method
  • your own special method

Standard method

This calculation method is suitable for most smaller businesses. You do not need to get HMRC approval to use the standard method.
For each VAT Return period:

1. Work out how much input tax relates to your taxable supplies.
2. Work out how much input tax relates to your exempt supplies.
3. Work out how much input tax relates to both your taxable and exempt supplies.
4. Calculate your taxable percentage. Do this by dividing the value of your taxable supplies by your total supplies. This can normally be rounded to next whole number.
5. Apportion your input tax relating to taxable and exempt supplies.
a) multiply the result at 3 by the result at 4 to get your taxable input tax
b) the remaining input tax is your exempt input tax
6. Add together the result from 1 and the result from 5a. This is the total taxable input tax you can claim.
7. Add together the result from 2 and the result from 5b. This is your total exempt input tax
8. Apply the de-minimis test to check if you can recover your exempt input tax. See step 8 in the example later in this guide.

You then repeat this process for the annual adjustment at your tax year end. See the section later in this guide on annual adjustments.

Changes to the standard method

On 1 April 2009 changes were introduced to make the standard method simpler. One of these changes - known as widening the scope of the standard method - is compulsory and affects businesses that make:

  • supplies of services to customers outside the UK
  • certain financial supplies such as shares and bonds
  • supplies made from establishments located outside the UK

Read more about changes to the standard method in VAT Information sheet 04/09 (Opens new window)

Example of standard method

Step 1 Input tax relating to taxable supplies
Input tax relating entirely to taxable supplies £12,500
 
Step 2 Input tax relating to exempt supplies
Input tax relating entirely to exempt supplies £7,500
 
Step 3 Input tax relating to taxable and exempt supplies
Input tax relating to both taxable and exempt supplies £5,000
 
Step 4 Calculate your taxable percentage
Exempt sales £50,000
Taxable sales (excluding VAT) £80,000
Total sales £130,000
Divide your taxable sales by your total sales and multiply the result by 100

Your taxable percentage = 80,000 / 130,000 × 100 = 61.53%
61.53% is rounded up to the next whole number.

Your taxable percentage = 62%

 
Step 5 Apportion your input tax relating to taxable and exempt supplies
Part a

Taxable input tax = step 3 × step 4 = £5,000 × 62% =

£3,100

Part b

Exempt input tax = £5,000 × 38% =

£1,900

 
Step 6 The total taxable input tax that you can claim
Total taxable input tax = step 1 + step 5a = £12,500 + £3,100 = £15,600
 
Step 7 The total exempt input tax that you can’t claim
Total exempt input tax = step 2 + step 5b = £7,500 + £1,900 = £9,400
 
Step 8 Check if you can claim any of your exempt input tax - de-minimis test
Is your exempt input tax not more than £625 per month, or £1,875 per quarter? No - £9,400
Is your exempt input tax not more than 50% of your total input tax in the quarter? Yes

If the answer to both questions is yes you can claim back your exempt input tax. In this case the answer to the first question is no, so you can’t claim back your exempt input tax.
This is known as the de-minimis test.

 
Step 9 Overall result
Taxable input tax that you can claim £15,600
Exempt input tax that you can't claim £9,400
Total input tax for the period £25,000

When you can reclaim all your input tax relating to exempt supplies

If you can show that you have paid only a relatively small amount of input tax on your purchases that relate to your exempt sales or other supplies you may be able to reclaim all of that input tax.

You'll be able to reclaim all such input tax in the relevant period if both the following are true:

  • the amount isn't more than £625 per month on average
  • the amount isn't more than half of your total input tax reclaimed

On 1 April 2010 changes were introduced to simplify the way you calculate whether you can reclaim all your input tax relating to your exempt supplies.

Find out more about the simplified calculations in VAT information sheet 04/10 (opens new window)

However you will not be able to recover any exempt input tax if you are approved to use the 'combined method'

Read more about the combined method calculation in VAT Information Sheet 06/11

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Annual Adjustments, including standard method override

Once a year - usually at the end of your VAT tax year - you must review how much input tax you've reclaimed throughout the year and make an adjustment.
You need to:

  • Check your VAT calculations. Were the goods and services you bought and that you reclaimed input tax on used entirely for taxable supplies? Were the goods and services you bought which you didn't reclaim input tax on used entirely for exempt sales? Were the goods and services you used partly for taxable supplies and partly for exempt supplies used in the proportion you calculated?
  • Make any necessary adjustments on your VAT Return. This is normally done on your first return for the next tax year but can be on your last VAT Return of the current year if you prefer. HMRC doesn't consider these adjustments to be errors.

Standard method override

If the standard method does not give a fair and reasonable deduction of input tax, you may need to make an adjustment. This is known as the standard method override. You must do this at the same time as your annual adjustment calculation.

Find out more about the standard method override in VAT Notice 706

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Special method

If you feel that the standard method isn't right for your business you can create your own method to reflect your unique business circumstances.

HMRC has to approve your special method in writing before you can use it. You need to tell HMRC about your business type, and the types of supplies you make and your costs structure. You will normally have to show how your method works by using actual figures from your business. To obtain approval, you must declare that the proposed special method is 'fair and reasonable'.

If HMRC decides not to approve your special method they'll tell you why and ask you to come up with a new one.

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Non-business use of purchases in a partly exempt business

You can't reclaim any VAT you pay on goods and services that aren't for business purposes.

If your business is partly exempt and you buy goods or services that you use partly for business and partly for non-business purposes, in order to reclaim VAT, you must follow both these steps:

  • find out how much of the VAT on your purchases relates to your business purposes
  • use your partial exemption method to find out how much of your business VAT you can claim

Find out how to split VAT between business and non-business use

With effect from 1 January 2011 you may apply for a special method which combines your business/non-business (other than private use) and partial exemption calculation. Using a combined method may reduce the number of calculations and help to reduce costs.

Read more about the combined method in VAT Information Sheet 06/11

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When you may waive exemption

If you sell, lease or let commercial land or property, you can choose to waive the exemption and to charge VAT at the standard rate. Input tax used to make taxable supplies can be reclaimed.

More about opting to tax property in VAT Notice 742A

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Keeping records if your business is partly exempt

If you make both taxable and exempt supplies, you must keep a separate record of your exempt sales and details of how you've worked out how much VAT to reclaim.

Get details of the VAT records you need to keep

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Acquiring or creating a capital asset

If you acquire or create an expensive capital asset you may have to use the Capital Goods Scheme to adjust how much input tax you initially reclaimed in future years. The scheme applies when your capital spending, net of VAT is:

  • £250,000 or more on land or buildings, or on building or civil engineering works
  • £50,000 or more on a single computer or piece of computer equipment

If your business has an asset and the extent to which you use it to make VAT taxable supplies - rather than exempt supplies - varies over the following five or ten years (depending on the asset), you'll have to adjust the amount of input tax you reclaimed. You can reclaim more if the proportion of your taxable supplies increases, but you'll have to repay some if it decreases.

If you purchased your asset before 1 January 2011, the value for determining whether it falls within the Capital Goods Scheme is only based on your spending for business purposes.

If you purchase your asset on or after 1 January 2011 the whole value must be included - not just the business value. For these assets, as well as making adjustments if the extent of taxable and exempt use changes, you'll also have to make adjustments if the extent to which they are used for business, as opposed to non-business, changes.

From 1 January 2011, if you purchase an aircraft, ship, boat or other vessel and your capital spending is £50,000 or more, you will have to use the Capital Goods Scheme.

Read more about the changes to the Capital Goods Scheme in VAT Information Sheet 06/11

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More useful links

More about partial exemption in VAT Notice 706

More about exempt supplies in VAT Notice 700/1

More about exempt supplies and partial exemption in VAT Notice 700

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