VAT - Partial Exemption Opportunities for Financial Services Businesses
Written by Kamlesh Chauhan, Senior VAT Manager at haysmacintyre
Most businesses in the financial sector are not entitled to reclaim the full amount of VAT that they incur on costs because they are partly exempt for VAT purposes. This is a complex area of VAT, and as the VAT year end approaches for most, now is a good opportunity to take stock of your VAT position. We often find many businesses are not minimising their VAT costs effectively, and are unaware of the requirements around their VAT year end (which is usually March, April, or May).
To complicate matters, rules governing VAT are continually changing due to new legislation, updates in HMRC’s guidance, and various case law precedents released over time. In the current climate, with the need to increase tax revenues, the corporate finance sector is an area that could easily be targeted by HMRC. A simple error, such as treating the VAT treatment of a transaction incorrectly can have knock on effects on your VAT recovery and your annual adjustment figures, leading to a significant amount of VAT being at stake, especially if the errors occur consistently over time as HMRC can assess going back for a four-year period.
For those that receive exempt income, (typically firms that arrange corporate transactions such as M&A activity, debt restructuring, divestments, IPOs or debt and equity private placements) an annual adjustment must be carried out at the end of each VAT year. This requires you to apply the normal VAT recovery method using annual data, rather than on a quarter-by-quarter basis. The difference between what can be reclaimed on an annual basis, compared to with what was claimable in the individual VAT return periods, then forms the annual adjustment which may be in your favour.
Many businesses simply fail to carry out an annual adjustment, or just get the calculations wrong which can lead to being penalised by HMRC, so it’s important to check you are doing it correctly – seeking professional help will of course aid this. It is crucial that you have applied an annual adjustment for each of the last four years.
If you are partly exempt there is an additional adjustment required for the VAT recovery claimed on expenditure relating to capital assets, including any commercial property (purchase and/or refurbishment) costing over £250,000 and computer hardware costing over £50,000. This is dependent on the change in the annual adjustment recovery rate, from the rate applied to the original year of purchase, and use of the asset to the rate calculated in each subsequent adjustment year for a period of 10 years (an adjustment period of 10 years is applied for all commercial property capital assets). If an asset is disposed of within the 10-year adjustment period, the remaining periods will be calculated based on the VAT treatment applied to the disposal.
In terms of the implications for non-compliance (whether intentional or not), HMRC will seek to charge penalties and interest. The amount will range from 15% to 30% of the VAT owed for a “careless” error identified by HMRC. Deliberate or concealed errors will attract even higher penalties. The actual penalty amount is subject to HMRC’s assessment of whether the business took “reasonable care” or not in making the error.
It is worth considering applying for the use of a special method of partial exemption. For most businesses in the financial services sector, this needs to be agreed in writing with HMRC, otherwise a method based on turnover must be applied. A more beneficial method can be based on the number of projects or transactions being worked on, or based on a sectorised approach with different methods for VAT recovery in each part of the business. Although it can be difficult to agree the method the benefits can be significant. For those with a special method already in place, it is always worth reviewing whether it is still reasonable for the business as this may have been agreed with HMRC some time ago, after which business operations have changed.
It is crucial to keep on top of your VAT position, with regular annual reviews. Failing to do so can leave the business at a disadvantage. We would encourage all partly exempt businesses to seek specialist advice to ensure that they not only avoid the pitfalls, but also take advantage of potential improvements to their VAT recovery position. Regular reviewing of your VAT position by external advisers also demonstrates, if any errors do arise, that “reasonable care” is being taken by the business, which will help mitigate and reduce any penalties that HMRC may seek to apply.
Kamlesh Chauhan is a senior VAT manager at haysmacintyre. He can be contacted on +44 20 7969 5584 or by email: email@example.com.