Is incorrect attribution of VAT costing you money

Your company makes both VATable and exempt sales, which means it can’t recover the VAT it pays on some purchases. Working this out involves several steps. How can you ensure you maximise the VAT reclaimable?

Partial exemption

When tax experts give advice on partial exemption (PE) they tend to concentrate on finding the best formula that will maximise the input tax (VAT on purchases) you can reclaim (see The next step ). However, before you get to that stage there are important steps to be taken, and if you get them wrong you could cancel out the advantage before you start.

Direct attribution

A business that makes exempt and VATable sales must identify which purchases are used to make:

VATable sales (standard, zero and lower-rated and certain sales outside the scope of VAT)

exempt sales

a mix of VATable and exempt sales.

Where purchases are used solely for VATable sales, all the input tax can be reclaimed, but if they’re used wholly for exempt sales, none of it can. Allocating the VAT to each type of sale is known as direct attribution. After that, for whatever input tax is left, known as residual VAT, typically overhead costs, e.g. accountancy fees, office costs etc., a PE formula must be used to work out how much of it can be reclaimed.

Trap. If you attribute input tax incorrectly you’ll either lose out on some of it or reclaim more than you should. The latter might drop you in hot water with HMRC and result in penalties.

How good is your bookkeeping?

Good bookkeeping is essential to ensure correct attribution of input tax. If you don’t keep the records for your business, it’s vital that whoever does knows which type of purchase an invoice relates to, i.e. exempt, VATable or residual. You might know at a glance, but your bookkeeper might not.

Example. You’re a residential property developer who also lets out homes on short terms. Selling the properties is VATable while letting is exempt. You buy large quantities of building material, so unless your bookkeeper knows which properties they are to be used for they can’t be sure to allocate the VAT shown on the invoice correctly.

Tip. Make sure someone with knowledge of the purchase marks invoices to show what type of supply they relate to. Alternatively, provide a comprehensive list to your bookkeeper that will enable them to identify it.

Mixed supplies

A problem arises where a supplier’s invoice covers items you’ll use for VATable and exempt supplies. HMRC says the input tax isn’t directly attributable and so the PE formula must be used to work out the VAT that is reclaimable, even where, say, 90% was used for taxable supplies. If the formula gives a lower rate of recovery, you’ll lose out. Conversely, if it allows a greater reclaim it’s OK to use it.

Tip. If it’s in your favour to do so ask the supplier to split the purchase between two invoices; one for the supplies you’ll use for VATable sales and the other for exempt material. That way the VAT can be attributed precisely.

Ensure whoever does your bookkeeping is informed if a purchase will be used to make VATable or exempt sales. All VAT can be reclaimed for the former, but none for the latter. Where a purchase relates to both types of sale, it can be advantageous to ask the supplier to split their invoice between the two.

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Is incorrect attribution of VAT costing you money

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