VBNB33000 - VAT Business and Non-Business: Principles: Different types of Apportionment Methods

Organisations are required to use an apportionment method that will produce a fair and reasonable apportionment of tax and is not overly complex to operate or check. They should make a record of the method used for their apportionment calculations. This should be readily available to HMRC on request.

An organisation should keep its method under review and make necessary adjustments if there are significant changes in the nature or levels of business/non-business activities as the method in use may no longer give an accurate and reasonable result.

A method used by organisations with regular non-business activity should normally incorporate an annual adjustment calculation for the costs incurred for both taxable and non-business activities.

The following are examples of commonly used apportionment methods. The list is not exhaustive.

A single or combination of methods can be used by an organisation provided the outcome fairly reflects how the costs incurred have been used for mixed business and non-business use.

Income based methods

Income based methods are the most common business/non-business apportionments.

Income that is outside the scope of VAT is an indicator but it is not determinative of non-business activity. Such income may be in the form of subsidies which could also serve to support taxable activity.

They usually work by the business:

  • treating the income it receives from making business supplies as ‘business income’; and
  • treating the income it receives from outside the scope sources as ‘non-business’ income.

The apportionment is calculated each quarter by dividing the business income by the total income:

Total income from business supplies (business income) = 2000
Total income from grants (non-business income) = 3000
Total income from all sources = 5000
Apportionment (2000/5000) = 40%

In this example, 40% of the input VAT on costs incurred on mixed-use is treated as input tax.

Income methods:

  • are simple;
  • rely on accounting information that is readily available; and
  • can be easily checked by HMRC.

Sometimes a simple income-based method may not give a fair and reasonable result. This will be the case if, for example where the mix of activity does not reflect the mix of outside the scope funding and business income. Examples include:

  • An organisation that spends most of its time and resources on non-business activities may still get most of its income from business supplies. If this is so, an income method would give a result that does not reflect the real non-business use of most of the mixed-use VAT bearing expenditure;

  • Where the commercial activities of an organisation are partly subsidised by grant income, if the full value of the grants were to be included in the denominator of the calculation (as non-business income) the value of input tax would be understated;
  • Conversely, any complete exclusion of subsidising outside the scope income from an apportionment calculation would only be sound where the funding subsidies both business and non-business activities equally.
  • The inclusion of large one-off receipts, such as a capital grant (whether attributable to business or non-business activities) may distort the calculation of input tax in the period(s) the capital grant is received.

However, income-based methods might be capable of being adapted satisfactorily.

For example,

  • Where the grant funding is used exclusively to subsidise business activities, the value could be included in both the numerator and denominator of an income-based calculation.
  • Where the grant funding is used in part to subsidise business activities, the full value of the grant funding could be included in the denominator of the income-based calculation and the element supporting business activity would be included in the numerator.
  • Where it is shown that the grant supports both business and non-business activities equally, the value could be excluded from the calculation.

The value of the one-off grant for a capital development could be excluded from the BNB calculation if it is found to be distortive.

Complex income methods can work well when income is the best indicator on which to base a method. However, sometimes they can lead to a calculation that is over complicated to operate and monitor. When this happens, it is usually better to find another simpler method based on a different indicator.

Although an income based method is given as an example in section 32 of The VAT Guide (link is external), HMRC does not have an automatic preference for such methods. They are acceptable only if they give a fair and reasonable result and are simple to operate.

Expenditure based methods

In this type of method, the business applies the ratio of business/non-business expenditure to the non-attributable tax.

They are only appropriate if the business can:

  • attribute most of its expenditure into distinct business and non-business categories; and
  • this ratio is a fair reflection of business and non-business activities.

When there is little directly attributable expenditure, in proportionate terms, these methods give a misleading result and should not be used. An example of this would be where most of the tax incurred is non-attributable.

Expenditure based methods are also not appropriate if the ratio of attributable expenditure is likely to be different from the extent of business use of the non-attributable goods and services.

For example, a charity with mostly non-business expenditure may buy a computer system to make taxable supplies of publications. It might only use the computer incidentally for non-business activities. When this happens, an expenditure-based method could lead to an apportionment that understates the business purpose behind the computer purchase.

Time based methods

Some organisations keep detailed records of the amount of time spent by staff on business and non-business activities. This can provide a useful basis for a method of apportionment if the business/non-business ratio of staff time reflects the extent of business use of non-attributable VAT bearing costs.

In some cases, staffing policy does not give a true indication of what VAT bearing goods and services will be used for. This is especially true if:

  • the organisation’s non-business work is staff intensive; and
  • its business activities are goods and services intensive.

For example, an organisation may spend 90% of its staff time making free supplies of verbal advice to members of the public. The remaining staff time is spent making taxable supplies of publications and on paid consultancy services.

Unlike the non-business work this business activity involves the charity spending money on goods and services rather than the non-VAT bearing wages of its staff. A simple time-based method would lead to an apportionment that understated the true balance of business use of the overhead goods and services.

Transaction based methods

These methods rely on expressing business transactions as a proportion of all transactions such as:

  • paid admissions to a museum; or
  • books loaned out for a charge by a library

A common difficulty with such methods is that non-business activities often do not involve recordable transactions. In contrast the business activities will involve making charges and making distinct, recordable supplies. In such cases a transactions-based method can lead to an unfair result.

HMRC staff will not automatically dismiss transaction-based methods. However, we will want to be sure that they are founded on a valid indicator of business and non-business activity.

Fixed apportionment

This method of apportionment is where a business adopts a fixed percentage figure. It then applies this to the total non-attributable VAT it incurs.

This can be an acceptable approach in cases where:

  • the balance of the activities of the business does not fluctuate; and
  • there is a good reason for adopting a percentage.

It can also be effective for those who:

  • normally only undertake business activities; but
  • undertake a one-off non-business project involving a specific item of expenditure.

An example of this would be where a company hires an entertainer to provide a free Christmas party to the children of its employees and those from a local school.

HMRC have agreed simplification arrangements with certain trade sectors.

For more information on apportionment, refer to Notice 700 The VAT Guide, section 32