In summary, the key areas for discussion are:
- the standard method
- the de minimis rules
- combining partial exemption and non-business calculations
- the Capital Goods Scheme
The consultation expands on these key areas by seeking comments on suggestions under five main sub-headings as follows:
1. Partial Exemption
Comments are invited on the following proposals:
a) An in-year provisional recovery rate using the prior-year annual recovery percentage, which will avoid having to do a standard method calculation each time a VAT return is completed;
b) Earlier annual adjustment, which would see the annual adjustment being part of the year-end VAT return to reduce the number of calculations made each year from five to four.
c) A use-based option for start-up businesses, allowing recovery in line with ‘use’ if the standard method is unsuitable. The business would select its own calculation which would not be challenged by HMRC if 'fair and reasonable'. However, HMRC have not given any guidance on what they would consider 'fair and reasonable', so this may prove problematic.
d) Inclusion of certain overseas supplies in the standard method (removing the need to carry out separate Reg 103 calculations). However, there are suggested exclusions for those supplies which HMRC have historically considered distortive, such as issues of shares and bonds, and supplies made from overseas establishments (e.g. foreign branches).
e) Alternative standard methods if the current turnover-based calculation is unsuitable. HMRC is suggesting 'sector-specific frameworks' to assist with the formulation of proposed methods. However, it is not clear if HMRC actually has the power under EU law to do this.
2. The De Minimis Rules
The proposal is to simplify the test used by small partly exempt businesses to determine if they should restrict recovery of an element of their input tax. In brief, they are as follows:
a) Undertaking a calculation only on an annual basis;
b) Simplifying the test (i.e. an alternative to the full partial exemption calculation);
c) Raising the monetary limit, which has been long overdue given year-on-year rises in costs!
3. Partial Exemption and Business/ Non-Business calculations
The proposal is for the currently separate calculations to be amalgamated into a single one, something that would be of particular interest to charities.
4. Simplifying the Capital Goods Scheme
The proposals include the following possibilities:
a) A pooling of capital items to reduce the number of calculations needed (e.g. a refurbishment which might otherwise include several separately qualifying items);
b) Reduce the number of items subject to the CGS by increasing the qualifying threshold;
c) Reduce the current £50,000 threshold for IT expenditure to take account of the reduced cost of hardware over recent years, or redefine qualifying IT spends to exclude hardware which HMRC know can be obsolete before 5 years have elapsed, but include services.
d) Clarification of the 'start-date' to give certainty on the beginning of the adjustment period. Currently, reference is made to a number of different events which define 'first use', such as importation, acquisition etc. HMRC is proposing to remove these definitions so that the CGS adjustment period begins simply from 'first use'. How self-evident 'first use' actually is, and whether it is sufficient as a phrase in itself, is another issue that may prove problematic.
e) Simplifying the treatment of part-disposals of capital items. The suggestion is that the business should carry out the final adjustment on the input tax for the part disposal. This would mean that it would only be required to continue making adjustments in relation to the part of the capital item still remaining in the business.
f) Introducing other definitions as follows:
- Removing the 10% additional floor area condition when considering whether alterations are qualifying.
- Removing self-supply charges arising before 1 March 1997 on the basis that capital items of this age are unlikely to still require adjustment.
- 'Simplifying' the definition of a refurbishment by widening the scope for qualifying items beyond whether or not they are fixed, to whether they are capitalised in the accounts.
- Simplifying the treatment of leases of less than 10-years, so that the CGS adjustment period coincides with the period of that lease.
5. Principal of Use
Annex A2 of the consultation sets out the definition of 'use' as it has evolved through case-law with the tests that now exist (i.e. whether a 'direct and immediate link' exists between taxable transactions, and whether the 'costs are borne as components of the transaction and the price'), and also covers the 'flexibility' afforded by Reg 103 to reflect the principle of use.
Responding To The Consultation
Responses are to be sent to HMRC’s Partial Exemption Policy team by 30 September 2008, detailing views on perceived pros and cons of the proposals, and any further comments or concerns. The Statement of Confidentiality at Annex A3 details HMRC's right to disclose or publish responses to this consultation (including personal information).