Your guide to understanding VAT recovery as a local authority or other public body
Local authorities and other public bodies covered by section 33 of the 1994 VAT Act can recover VAT incurred on costs associated with:
- non-business activities,
- taxable business activities where the body is VAT registered (subject to the normal rules), and,
- exempt business activities (where the input tax incurred in relation to exempt activities is considered to be insignificant).
The insignificant amount is tested using a calculation called the section 33 recovery model, more commonly referred to as the partial exemption calculation.
This calculation is crucial to ensuring your public body can monitor and, where possible, mitigate the amount of irrecoverable VAT.
Here, we will help you understand the importance of the partial exemption and how to prepare for the calculation.
How to treat VAT incurred
Normally, businesses and other organisations that only make exempt or non-business activities cannot recover VAT incurred on costs associated with these activities. However, special VAT recovery rules apply to section 33 public bodies that enable VAT to be recovered as below.
The section 33 partial exemption calculation enables public bodies to obtain a refund of VAT incurred related to non-business activities.
A public body can recover the VAT it incurs on its non-business activities only if it:
- Places the order
- Receives the supply
- Receives a tax invoice addressed to it
- Pays from its own funds (including funds awarded to it).
Taxable business supplies
A public body registered for VAT can recover VAT incurred on purchases used for taxable business purposes (subject to the normal rules).
The body must demonstrate its entitlement to any VAT claimed, although it is not required to distinguish between VAT attributable to business and non-business activities.
Exempt business supplies
Public bodies can recover VAT incurred on exempt supplies, where this is calculated to be an insignificant proportion of the total VAT incurred.
The insignificance test
Exempt input tax is considered insignificant and recoverable if it is less than one of the following:
- £7,500 per annum, or
- 5% of the total VAT incurred on all purchases in a year.
How to prepare for the partial exemption calculation
Step 1. Identify exempt activities
All budget headings and cost centres containing exempt activities must be identified and listed.
Step 2. Identify all expenditure which incurs standard-rated VAT.
Record all capital and revenue expenditure (ex VAT) that relates to the activities at Step 1.
Step 3: Calculate the percentage of VAT related to exempt supplies
The total of the standard rated expenditure identified in Step 2 and multiply it by 20%
No further calculations are required if this amount does not exceed the insignificance test and VAT remains recoverable. If this amount breaches the insignificance test, the body needs to perform a more detailed analysis of its costs to mitigate irrecoverable VAT.
If, after detailed analysis, the insignificance test is breached yet again, VAT attributable to exempt supplies cannot normally be recovered.
At this point, the section 33 public body can perform the same calculation over seven years. If the average exempt input tax over seven years is insignificant, it can be recovered in the year of the breach.
Performing the partial exemption calculation every year is crucial for two reasons.
- Compliance: The calculation demonstrates to HMRC that the public body is entitled to recover the VAT reclaimed on its returns.
- Budgeting: In real-time, the public body can monitor the effect of incurring VAT on exempt activities.
Failing to perform the calculation results in public bodies facing VAT assessment and penalties from HMRC. In addition, budget holders who need to fund unexpected irrecoverable VAT often find their service or project is no longer viable if the public body unexpectedly fails the insignificant test.
Alternatively, tap into our vast experience and knowledge and utilise our partial exemption support services.