Partial exemption: de minimis and the standard method
Cobalt Lettings Ltd owns a four-storey building in Leeds. It lets six flats to residential tenants for exempt rents of £240,000 a year and two commercial units to shops for standard-rated rents of £160,000; Cobalt has opted to tax the commercial units. It also charges the shop tenants £40,000 a year for management services, which are standard-rated. In the year to 31 March 2025 it incurred input VAT of £18,000 on repairs to the shared lift, £9,000 on refurbishing one commercial unit, £6,000 on redecorating a residential flat, and £4,000 on accountancy fees covering the whole business. Cobalt has no special partial exemption method. Its accountant says the company can recover all the input VAT because taxable turnover is nearly half of total turnover.
1. Calculate Cobalt's recoverable input VAT and test whether the de minimis limits apply.
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First attribute input VAT:
- Commercial refurbishment £9,000: directly attributable to taxable supplies, recoverable in full.
- Residential flat redecorating £6,000: directly attributable to exempt supplies, not recoverable.
- Shared lift repairs £18,000 and accountancy £4,000: residual input tax of £22,000.
The standard method uses turnover: taxable turnover = £160,000 + £40,000 = £200,000; exempt = £240,000; total = £440,000. Taxable proportion = 45.45%. Recoverable residual = £22,000 × 45.45% = £10,000.
Total recovery = £9,000 + £10,000 = £19,000. Irrecoverable = £18,000.
De minimis: exempt input tax = £6,000 + (£22,000 × 54.55%) = £18,000. The limit is £7,500 a year and 50% of total input tax. £18,000 exceeds £7,500, so de minimis does not apply even though it is under 50% of £37,000. Both tests must be met.
2. Respond to the accountant's claim and advise how Cobalt could improve VAT recovery.
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The accountant is wrong. Recovery is not based on turnover being nearly half; the exempt input tax must fall within the de minimis limits, and it does not.
Cobalt should consider a special partial exemption method if the standard method does not reflect actual use. For example, the lift may be used more by the commercial units, or floor area may be a fairer basis. A special method requires HMRC approval. Cobalt cannot option to tax the residential flats, because the option to tax is not available for residential accommodation. It could review the legal structure, but simply transferring the flats to another company may not improve recovery and could create VAT and anti-avoidance issues. It should also ensure the commercial refurbishment is invoiced to the company and that the VAT is not blocked.
3. Explain the annual adjustment and the records Cobalt should keep.
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An annual adjustment is needed at the end of the VAT year. If Cobalt recovered VAT provisionally using estimates, it must compare the provisional recovery with the final figures and adjust the next return. A longer period adjustment may also be required if the partial exemption standard method is used and the business has a longer period. Cobalt should keep the calculation and evidence of the turnover split, attribution of costs and the de minimis test.