For the past couple of months, I’ve been working on and off on an article about the partial exemption standard method and why I think it’s one of the most difficult areas of VAT. Everyone knows that partial exemption is difficult, but I think that a lot of people – and probably mostly you accountants out there – are lulled into a false of sense security by relying on the fact that you can use the “standard” partial exemption method and follow a relatively simple set of rules.
And I’m sorry to tell you, YOU ARE SO WRONG. In fact you should be attaching crampons to your accountancy certificates and taking out additional professional insurance for the stress that it can cause. The simple thing is that this “method” is one of the major causes of VAT problems for businesses, particularly those in the SME sector.
When standard isn’t straightforward
The reason is this. The method is based on following a number of steps that are laid out in the legislation and at first glance they appear to be relatively straightforward. The problem is that we all think that we understand what the rules say. But we don’t. These rules have to be among the most difficult rules that I’ve ever had to interpret during my 25 years in VAT and the fact that they seem to be simple makes them so dangerous.
A good example is the reference to “incidental” exempt supplies. How do you define “incidental”? Have you ever thought about it? However there have been several VAT Tribunal cases over the years where HMRC and the taxpayer have disagreed about whether certain VAT costs should be treated as directly attributable to taxable or exempt supplies or whether the VAT is residual input tax. And that's before they get into issues of which figures to include in the turnover based calculation or whether "use based" methods are more appropriate.
I wouldn’t expect accountants and most business owners to appreciate this. But you’ve only to flick through the several hundred case reports about partial exemption to realise that HMRC takes these things very seriously. In many respects, it’s probably safer for businesses to agree a special method with HMRC where each step is defined and agreed in writing by both parties rather than rely on the standard method. Of course this can seem like an unnecessary hassle and expense, but I’ve spent more time over the years helping clients deal with problems arising due to the standard method than agreeing special methods. In many cases, it will be more cost effective to invest in the professional fees of agreeing a special method upfront than deal with the hassle arising using the standard method in later years.
Okay, back to the article and pulling my hair out by the roots...
Marie