Claiming input VAT on purchases requires the purchases to be attributed to taxable sales.
The relevant legislation is VAT Regulations 1995, Regulation 101. Paragraph (2) requires the process of attribution to be carried out in stages and involves the identification of: purchases used exclusively in making taxable supplies; purchases used exclusively in making exempt or non-taxable supplies; and purchases used in making both taxable and non-taxable supplies.
Many different businesses are required to determine their input tax by a process of attribution. A business might make taxable supplies with the occasional exempt or non-taxable supply requiring the extent to which input tax is attributable to taxable supplies to be determined; and there are those making predominately exempt supplies such as financial service providers and advisers, residential landlords, healthcare providers, bookmakers/gambling businesses, charities, etc. who might make the occasional taxable supply, against which reclaimable input tax is required to be determined. Businesses making fully taxable supplies might also have some affected activities: for example the supply of shares is an exempt activity, and companies often issue shares or hold shares instead of keeping funds in a bank account.
The process of attribution is carried out by businesses before their partial exemption calculation. It is not straightforward and should be performed with care. Attributing too many purchases to exempt supplies will result in a lower input VAT claim for the taxpayer and the converse could lead to too much VAT being claimed, resulting in penalties and interest.
The legislation is not helpful, with Regulation 101(2)(e) stating that “attribution … may be made on the basis of the extent to which the goods or services are used or to be used by him in making taxable supplies”. To shed some light on this issue, the process of attribution is considered below in some practical examples.
Exempt and non-exempt income
A number of businesses have multiple income streams, some exempt and some taxable.
Consider a shop with a flat above, all owned by the same person. The shop’s supplies are taxable, but the flat rental is exempt. It will be necessary for the owner to determine which expenses are exclusively used in making supplies from the shop, which expenses are exclusively used in renting the flat, and which expenses are used partly by both.
How should the owner approach this procedure?
Some costs will be relatively easy to attribute. Stock will be attributable to the standard rated sales in the shop. The cost of advertising the flat for rent will be exclusively used in the exempt rental business. However, for many costs attribution will not be immediately clear. It should be remembered at this stage that, the more that is not directly attributable to exempt supplies, the better for the taxpayer. This is because such costs will become an overhead of the business and the input VAT will be recoverable, at least in part and perhaps in full if the de minimis rules are met.
The process of attribution therefore deserves close attention, as more might fall into the overhead category than might at first appear.
This was demonstrated in the recent case of North of England Zoological Society v Revenue and Customs Commissioners ( UKFTT 287 (TC), published on 1 July 2015). Zoo admission is exempt, but its other revenue is standard rated such as the café, gift shop, animal encounters, etc. The question was whether animal-related expenses were exclusively attributable to exempt zoo admission.
HMRC argued that there was no direct and immediate link between animal-related expenses and catering, retail and other taxable revenue streams, and therefore they could not be an overhead. However, the tribunal found for the taxpayer and said “the animal related costs are a cost component of the catering and retail supplies”.
Many businesses hold cash surpluses before they use the funds for particular projects. These surpluses might be invested in shares or funds rather than bank accounts, and this can incur significant taxable costs in management and other fees.
Being an exempt financial activity, it might be thought that the input VAT on the costs of operating a fund or trading in shares would not be recoverable. This was shown not to be the case in a First-tier Tribunal decision, which was recently confirmed by the Upper Tribunal, in the case of University of Cambridge v Revenue and Customs Commissioners ( UKUT 305 (TCC), published 19 June 2015).
The Upper Tribunal ruled that the taxpayer did have “a right to deduct … input tax incurred on the cost of operating the endowment fund on the basis that it should be characterised as overhead expenditure.” Further analysis can be found in our article regarding the First-tier Tribunal decision: http://www.gabelletax.com/blog/2013/09/27/university-of-cambridge-recovering-vat-on-investment-fees/
Issuing new shares
The complexity of how to correctly attribute costs has been recognised for some time. A decision by the ECJ showed this in 2005.
A company issued new shares and used the income from their sales to fund the business and operations. It incurred significant costs in the decision-making process and in placing the shares. At first glance, these costs appear to be attributable to an exempt sale of shares. However, the ECJ concluded in Kretztechnik AG (C-465/03) that the issue of new shares was not an economic supply by the taxpayer and instead the costs were part of the company’s overheads and attributable to the overall business activity.
He might not have had VAT in mind, but in 1633 George Herbert wrote, “A man that looks on glass, on it may stay his eye; or if he pleaseth, through it pass”. Much the same applies when attributing purchases to supplies: a cost might be linked to one activity (e.g. the sale of shares), but that activity might sometimes be looked through with the cost ultimately being attributed to the overall business activity.
Determining the correct attribution of purchases is a difficult process and, conducted carefully, can result in a significant saving for taxpayers.