VAT – Input Tax that cannot be reclaimed

A VAT-registered business can reclaim the VAT that it incurs on business expenses. Most businesses expect to be able to reclaim all the VAT that they incur on expenditure. There are, however, a number of exceptions to this general rule.

The main types of VAT that cannot be reclaimed are:

• VAT incurred overseas
• “blocked” Input tax
• VAT on private or non-business expenditure
• VAT that relates to exempt supplies.

VAT incurred overseas

VAT can only be reclaimed if it is incurred in the UK. VAT incurred overseas is non-deductible. It may, however, be possible to reclaim the VAT incurred in an overseas jurisdiction from the tax authority overseas. For example, VAT incurred in Germany can be reclaimed from the German tax authorities. There are particular rules regarding the VAT that can be reclaimed and each country’s rules differ. There are agencies that will make a claim for the business if assistance is needed. Some countries do not provide VAT refunds to overseas businesses (such as New Zealand) and some countries do not have a VAT system (for example, the USA). The overseas VAT that is most frequently claimed reclaimed is incurred in EU countries.

Blocked input tax

HMRC has blocked businesses from reclaiming VAT on certain types of expenditure. This includes:

• cars
• certain building materials
• items sold under a margin scheme and other schemes
• business entertainment
• domestic accommodation.

Cars

VAT is usually not reclaimable on the purchase of a car unless the business is a car dealer, taxi business or driving school. When, however, a car is used exclusively in the business and is unavailable for private use the VAT on the purchase can be reclaimed. This can be a high bar to pass, as it is necessary to ensure that private use is not possible, the car is kept at the business preemies overnight and that the car is insured for business purposes only.

50% of the VAT incurred on a car that is leased or hired is reclaimable, but not on lease purchase or hire purchase agreements.

The VAT incurred on repairs and maintenance of a car used in business can be reclaimed in full.

VAT incurred on petrol or diesel costs can be reclaimed in full where the VAT fuel scale charge is applied. The fuel scale charge does not need to be applied where the VAT reclaimed only on fuel purchased for business use and not private use. HMRC will expect detailed mileage records to be kept.

Building materials

VAT cannot be reclaimed on certain materials used in the construction of new residential buildings that are supplied as a zero-rated sale or on a long-lease. This block of input tax is to prevent VAT being claimed on non-essential items or luxury items (such as TV sets) being included in a property that then benefits from a zero-rated supply. Specifically excluded are finished or prefabricated furniture other than furniture designed to be fitted in a kitchen. Also blocked is the input tax on materials to construct this fitted furniture. VAT cannot be reclaimed on electrical or gas appliances other than those that provide space heating or water heating. VAT also cannot be claimed on carpets or carpeting materials.

Margin and other schemes

There are a number of VAT accounting schemes, such as the margin schemes for second hand goods, the flat rate scheme and the Tour Operators scheme. VAT is not reclaimable on most expenditure for items within these schemes. Where a business is using any of these schemes further advice should be sought.

Business entertainment

VAT incurred on business entertainment is not reclaimable by the business providing the entertainment. Where hospitality is provided to guests, who are not employees, the VAT cannot be reclaimed. This includes product launches, presentations and other guest entertainments. HMRC regards entertainment to be the provision of food and drink, accommodation, entertainments, etc. Where there is a business purposes, such as advertising, the element relating to the non-entertainment business purpose can be reclaimed. It should be noted, however, that the entertainment of overseas customers is not blocked, the VAT incurred can be reclaimed.

VAT on entertainment expenses can usually be reclaimed when staff are entertained. Where guests are entertained at the staff party (such as spouses or partners of staff) the input tax incurred has to be apportioned between the staff and non-staff expenditure. Where the non-staff members are charged a fee for attending, VAT on this fee has to be accounted for to HMRC, but then all input tax can be reclaimed.

Domestic accommodation

VAT cannot be reclaimed on the cost of providing accommodation for company directors. Accommodation provided to sole proprietors or partners in a business is regarded as non-business expenditure and cannot be reclaimed. VAT can be reclaimed where the domestic accommodation is provided to employees and this accommodation is necessary for their employment duties.

Private or non-business expenditure

When expenditure has a mixed business and private/non-business purpose, the related VAT should generally be apportioned and only the business element claimed. When goods on which input tax has been claimed (such as an item of stock) are subsequently put to private or non-business use, there is a deemed supply for VAT purposes. Output tax is due on the cost of the supply to account for this private or non-business use.

Capital items, such as land, buildings, civil engineering works, computers, aircraft, boats, and other vessels which are purchased on or after 1 January 2011 are subject to an input tax adjustment to reflect actual use of the item over a period of years. This is called the capital goods scheme and is discussed below.

Exempt supplies

Where a business makes exempt supplies, it cannot reclaim all of its input tax (subject to a de minimis limit). An exempt supply is a supply that is not subject to VAT but where VAT cannot be reclaimed on expenses relating to the supply. This includes direct costs and a proportion of overhead expenses.

Often businesses do not recognise that they have made exempt supplies. Common exempt supplies include:

• many property transactions, both sales and lettings
• insurance
• betting, gaming and lotteries
• finance, including interest charges
• education
• health and welfare
• some sports activities
• some charitable and cultural activities.

It is important for the business to ensure that the supply it makes does fall within the exemption, otherwise VAT will need to be charged (although this does mean that VAT on expenses can be reclaimed).

The input tax that cannot be claimed is any VAT on expenses that can be directly attributed to the exempt supply, plus a proportion of the input tax on overheads, the input tax that is incurred for both taxable and exempt supplies. The standard method of determining this apportionment is to multiply the VAT incurred on overheads by the value of the taxable supplies made in the period, divided by the value of the total supplies made. This gives the amount of VAT incurred on overheads that can be reclaimed, the balance cannot be reclaimed.

For example, a business incurs £1000 of VAT on overheads, that is incurred for both taxable and exempt supplies. It makes taxable supplies in the period of £90,000 (excluding VAT). Total supplies made were £100,000. This means that the business can reclaim:

£1000 X £90,000/£100,000 = £900.

£100 has to be restricted along with any VAT that is directly attributable to the exempt supplies made.

This claim for VAT is regarded as a provisional claim for the period. The business is also required to make an annual adjustment in respect of their annual input tax and annual supplies to help even out any seasonal supplies.

Where the input tax that relates to exempt supplies is less than the de minimis limit, all the VAT can be reclaimed. The de minimis limit is not more than £625 per month on average during the period or tax year, and not more than 50 per cent of total input tax in the relevant period.

Where this standard method does not give a fair and reasonable result the business may apply to HMRC to use a special method. Also, where a fair result is not obtained an override notice may be issued by HMRC to alter the method of VAT recovery.

Input tax recovery for an exempt business is complex so please call us for advice in this area.

Capital goods scheme

Where capital items are used for exempt purposes, or partly for exempt purposes, or for private purposes, it is necessary to adjust the VAT incurred over a period of years to reflect the use of the asset over these years. This is called the capital goods scheme.

Assets included in the scheme are:

• land, buildings and civil engineering work costing more than £250,000
• computers and computer equipment costing more than £50,000
• aircraft, ships, boats or other vessels costing more than £50,000.

The VAT is adjusted over five years for computers, aircraft, ships and boats and ten years for real property.

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