Partial Exemption, De Minimis and an Option to Tax
Harbourline Ltd is VAT-registered and makes taxable consultancy supplies and exempt supplies of storage space from a building it owns. In the quarter to 31 March 2025 its input VAT was £48,000: £28,000 directly attributable to taxable supplies, £12,000 directly attributable to exempt supplies and £8,000 on overheads. Taxable turnover for the quarter was £672,000 and exempt turnover £168,000. The company has no special method agreed with HMRC and uses the standard method. It now wants to sell the building, which is let to three tenants, and the finance director asks whether it should opt to tax first, noting that "VAT is surely just added to the price and the buyer reclaims it".
1. Compute the recoverable and irrecoverable input VAT for the quarter under the standard method, and test the de minimis limits.
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Step 1 – Direct attribution
- Attributable to taxable supplies: £28,000 → recoverable
- Attributable to exempt supplies: £12,000 → irrecoverable
Step 2 – Apportion the residual (overhead) input tax
Taxable proportion = 672,000 / (672,000 + 168,000) = 672,000 / 840,000 = 80%
- Residual recoverable: 8,000 × 80% = £6,400
- Residual irrecoverable: £1,600
Step 3 – De minimis test
Exempt input tax = 12,000 + 1,600 = £13,600.
The test has two limbs and both must be met:
- £625 per month on average → £1,875 for the quarter. £13,600 fails this limb immediately.
- No more than 50% of total input tax → 50% × 48,000 = £24,000. £13,600 passes this limb.
Failing limb 1 is enough: the company is not de minimis.
Step 4 – Result
- Recoverable: 28,000 + 6,400 = £34,400
- Irrecoverable: 12,000 + 1,600 = £13,600
Caution: these quarterly figures are provisional. The standard method requires an annual adjustment after the year end, using the full year's turnover and input tax; if the annual result is de minimis, all input tax becomes recoverable (subject to any previous adjustment), which can produce a repayment.
2. The finance director wants to reduce the irrecoverable VAT. Identify the legitimate options and their limits.
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Option 1 – Remove the exempt turnover at source
The £168,000 of exempt turnover is storage rent from an unopted building. Opting to tax the building converts the rent into a standard-rated supply. Exempt turnover disappears, the residual apportionment becomes 100% recoverable, and the £1,600 per quarter (£6,400 a year) of irrecoverable overhead VAT is saved. Whether this nets out depends on the tenants' recovery position (see the next task) - the VAT simply moves from Harbourline to the tenants.
Option 2 – Agree a special method
A special method can be used only with HMRC's written agreement (or by using a prescribed sectorised method). It must be fair, reasonable and more accurate than the standard method. Examples:
- sectorising the business: allocate residual input tax to the storage sector and the consultancy sector, then apply a floor-area or usage-based formula to the storage sector;
- a transaction-count or staff-cost based formula where turnover is volatile.
A special method cannot simply pick the most favourable percentage; HMRC will test whether it reflects actual use. It is worth modelling before the year end, because the method must be applied consistently across the whole VAT year.
Option 3 – Check the exempt classification
Confirm the storage supply really is exempt (a licence to occupy land) rather than a taxable service (for example, storage combined with handling and logistics, or a serviced arrangement with significant ancillary services, which can be standard-rated). Reclassifying genuine taxable supplies increases recovery without any option to tax.
Option 4 – Cost structure
Shift overheads, where commercially possible, into costs directly attributable to taxable supplies (for example, a dedicated consultancy IT platform), which are fully recoverable.
3. Advise on the option to tax in the context of the proposed sale of the let building, addressing the finance director's assumption.
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What the option does to the sale
- Unopted: the sale of the building is an exempt supply. A sale of let property to a buyer who will continue the letting business can still be a transfer of a going concern (exempt TOGC), in which case no VAT arises and the buyer inherits the position.
- Opted: the sale is standard-rated at 20%, unless it is a TOGC. For a TOGC the buyer must be a taxable person who opts to tax the property and both parties must agree in writing that the TOGC rules apply; otherwise the VAT is charged on the price.
Why "the buyer just reclaims it" is wrong
Recovery depends on the buyer's own VAT position:
- a VAT-registered buyer making fully taxable supplies recovers the VAT - no real cost, but a 20% cash-flow and funding burden until the return is made;
- a charity, a pension fund, a doctor or any buyer making exempt supplies cannot recover it, so the VAT becomes a real cost and either kills the deal or forces the price down by up to 20%;
- a non-registered buyer cannot recover it at all.
On a building worth, say, £1,000,000, the VAT is £200,000 - far more than any partial exemption saving. The option should only be exercised if the realistic buyer pool can recover the VAT.
Other consequences to flag
- The option is irrevocable for 20 years (revocation is possible only in narrow circumstances, such as within six months of the option taking effect, or at the end of the 20 years).
- Opting affects all future supplies of the building, not just the sale - including any future letting to exempt or unregistered tenants.
- The capital goods scheme may require an adjustment on the sale if the VAT on the building's acquisition or refurbishment was at least £250,000 (10-year adjustment period for land and buildings).
- Any option must be notified to HMRC within 30 days of taking effect.
Recommendation: model the sale both ways, establish what the three tenants and likely buyers do, and only opt if the tenant and buyer profile is taxable. Do not opt purely to fix a £6,400 annual partial exemption leakage.