For UK businesses making both taxable and exempt supplies, partial exemption rules govern input VAT recovery. Pure-taxable businesses recover 100% of input VAT. Pure-exempt businesses recover none. Partial-exempt businesses (financial services, healthcare, education, property with mixed OTT/non-OTT) sit in between, recovering input VAT only to the extent it relates to taxable supplies. The standard method (turnover ratio), special methods (sector-specific approaches), de minimis limits (full recovery on small exempt amounts), the Capital Goods Scheme (10-year adjustment on high-value assets), and the annual adjustment are the technical mechanics. This is the most complex area of UK VAT and the area where specialist expertise pays back fastest.
The Standard Method
The standard method calculates recoverable input VAT based on turnover:
- 1Direct attribution: input VAT clearly relating to taxable supplies = 100% recoverable. Input VAT clearly relating to exempt supplies = 0% recoverable.
- 2Residual input VAT (overheads): apportioned by turnover ratio.
- 3Recovery percentage = (Taxable turnover / Total turnover) × 100.
- 4Round up to nearest whole percentage.
- 5Apply the percentage to residual input VAT to determine recoverable amount.
Worked example: standard method partial exemption
| Item | Amount |
|---|---|
| Total turnover | £500,000 |
| Taxable turnover (standard or zero-rated) | £350,000 |
| Exempt turnover | £150,000 |
| Recovery percentage | 70% |
| Direct taxable input VAT | £20,000 (100% recoverable) |
| Direct exempt input VAT | £8,000 (0% recoverable) |
| Residual input VAT (overheads) | £15,000 × 70% = £10,500 recoverable |
| Total recoverable | £30,500 |
De minimis limits
Where exempt input VAT is below de minimis limits, full recovery applies:
- Exempt input VAT below £625 per month on average (£7,500 per year).
- AND exempt input VAT no more than 50% of total input VAT.
- Both conditions must be met.
- When met: business treats all input VAT as taxable and recovers in full.
- Tested on each VAT period AND on the annual adjustment.
De minimis is a relief, not the default
A business below de minimis recovers 100% of all input VAT — much better than apportionment. This makes de minimis a useful planning tool: structuring inputs to fall below thresholds where possible.
Capital Goods Scheme (CGS)
For high-value capital assets, the CGS adjusts input VAT recovery over 10 years to reflect actual usage:
- Assets in scope: land/buildings over £250,000, computer equipment over £50,000, aircraft/ships over £50,000.
- 10-year adjustment period for property; 5 years for computer/aircraft.
- Initial recovery based on intended use; subsequent adjustments if actual use differs.
- Each year, recompute recovery percentage and adjust for the year's share of the original input VAT.
- Disposal during CGS period triggers final adjustment.
Apportioning overhead costs
Common overhead inputs in partial exemption:
- Office rent and utilities: typically apportioned by turnover ratio.
- Group accountancy and legal fees: by turnover ratio unless directly attributable.
- IT systems and software: by turnover ratio unless directly attributable.
- Bank fees on shared accounts: by turnover ratio.
- Marketing for the whole business: by turnover ratio.
The Partial Exemption Series
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Healthcare and education: sector-specific exemptions
Two sectors with substantial exempt supplies:
- Healthcare: medical care supplied by registered medical practitioners is exempt. Cosmetic procedures (non-medical): standard rate.
- Dental services: exempt where supplied by registered dental professionals. Cosmetic dentistry (whitening, veneers for non-medical reasons): standard rate.
- Education: tuition by qualifying providers (schools, universities, recognised qualification bodies) is exempt. Private tuition by individuals (not via institution): typically standard rate unless specific exemption applies.
- Care homes: exempt for residential care; mixed VAT treatment for additional services.
Financial services and insurance
Financial services and insurance are largely exempt:
- Banking services, lending, deposit-taking: exempt.
- Insurance: exempt (with insurance premium tax instead).
- Insurance broker commissions: typically exempt (treated as an insurance-related supply).
- Investment management: exempt for collective investment schemes; standard rate for portfolio management of individual portfolios.
- Recovery on overheads: typically very low (5-15% recovery percentage) unless specialist sector adviser optimises via special methods.
The annual adjustment
At the end of each VAT year, partial-exempt businesses must reconcile:
- 1Calculate total taxable and exempt turnover for the year.
- 2Calculate annual recovery percentage.
- 3Compare to recovery applied during the year (sum of quarterly amounts).
- 4Adjustment = annual percentage × annual residual input VAT minus quarterly recovery applied.
- 5Submit adjustment on the first or fourth quarter of the next VAT year (election determines which).
Partial exemption is the most complex area of UK VAT
A specialist Harrow VAT accountant designs the special method, runs the annual adjustment, and tracks CGS adjustments over 10 years.
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