Most of the updates are relatively minor and provide further details on how the new rules apply in practice. There is, however, one important change relating to directly attributable input tax incurred before 1 January 2021.
1) Directly attributable VAT
- VAT incurred before 1 January 2021 that was attributable to a specified supply made to a non-EU counterparty has always been recoverable in full, and remains so.
- Similarly, pre 1 January 2021 input tax that is attributable to an exempt supply made to an EU counterparty before 1 January remains irrecoverable in full, under the old version of the SSO.
- HMRC had previously stated that VAT incurred pre 1 January 2021 that was attributable to a specified supply made to an EU counterparty on or after 1 January 2021 would remain completely irrecoverable. The new guidance changes this position, so that this input tax is now fully recoverable (as part of the Annual Adjustment process).
- Input tax incurred on or after 1 January 2021 that is directly attributable to an exempt supply made to an EU counterparty prior to the change in the SSO should be treated as completely irrecoverable. The example given by HMRC is input tax which relates to the management of an insurance claim where the insurance contract was concluded in 2020 (or earlier). This will result in increased complexity for insurers who from now on will need to directly attribute such claims related costs not only by reference to the location of the policyholder but also by reference to the timing of the original supply.
2) Residual VAT
- HMRC’s overall position remains that taxpayers should carry out their Annual Adjustment in the normal way, but applying the different rules before and after 1 January to calculate the longer period recovery rate.
- HMRC have confirmed that taxpayers should not split their Annual Adjustment into two – the normal process will apply to all input tax, no matter when it was incurred during a partial exemption year which spans 31 December 2020.
- HMRC recognise that input tax that was previously directly attributable to exempt supplies made to UK and EU counterparties may now need to be reclassified as residual input tax as part of the Annual Adjustment process.
- Whether this is appropriate will depend on whether the input tax has been used to make exempt supplies before 1 January 2021, or whether it continues to be used to make both exempt and specified supplies after that date.
- For partial exemption years which ended on 31 December 2020, there is no right to revisit the partial exemption calculation in light of the changed SSO (except in the unlikely circumstance that supplies were made between 11pm and midnight of 31 December).
3) Provisional recovery rates
- Some taxpayers who have normally applied the prior year residual recovery rate have asked whether they can move to apply a quarterly calculation, so that they can use the higher recovery rate now rather than waiting until their next partial exemption year.
- HMRC’s position on this is clear – that this is not available except in limited circumstances, namely:
(i) If operating under the Standard Method, that this approach is applied to every VAT return quarter within the partial exemption year; or
(ii) Under a Partial Exemption Special Method, any change to the use of prior year recovery rates must be agreed as a formal change to the PESM with HMRC.
- HMRC have stated that they consider this delay to increased recovery as still being “fair and reasonable” as it represents only a timing difference and not a change to the amount of recoverable VAT itself.
- Taxpayers should already have ensured that their systems are set up to provide information about the number / value of supplies made to non-UK counterparties starting from 1 January, to replace the older “EU / non-EU” split previously required.
- The new guidance relating to both directly attributable and residual input tax will require all those making specified supplies to revisit their VAT recovery calculations. This can be done as part of the Annual Adjustment process, but for some taxpayers this will be a significant task and so should be prioritised before then.