VIT32000 - How to treat input tax: pre-registration, pre-incorporation and post-deregistration claims to input tax under regulation 111
Background
Only a person who is already registered for VAT can exercise the right to deduct input tax. However, there are certain circumstances before registration and after deregistration when relief from VAT is permitted. Under Regulation 111 of the VAT Regulations 1995, HMRC allows a business to treat VAT incurred when it was not registered for VAT as if it were input tax and sets out the time limits within which the relevant VAT must have been incurred.
Pre-registration
Where a business buys goods or services before it registers for VAT, to support taxable business activities when it is registered, it can recover the tax provided that:
in the case of goods, the goods remain on hand at the date of registration and will be used in the newly registered business. These goods must have been bought within the time limits that are set out in regulation 111; for businesses with a registration date after 1 April 2010 the time limit will be 4 years.
in the case of services, the supply was received not more than six months before the date of registration. Six months represents a period in which it is deemed that services obtained will relate to business activity carried on at the time of registration.
Tax incurred on goods on hand at registration (other than capital items - see below) cannot be deducted if the VAT was incurred outside of the time limits set out in regulation 111. This includes VAT incurred on services performed on those goods.
If a business is given a backdated registration date this becomes the relevant date for working out the extent of the time limits.
Businesses are not required to reduce the VAT considered in respect of pre-registration use of goods, unless those goods have previously been used in the making of exempt supplies or for non-business purposes. For example, VAT incurred on a van purchased by an ice cream seller three years before registration and used before and after registration only for selling ice cream would be recoverable in full, even though it was used for 3 years when no tax was due on sales.
For capital items within the Capital Goods Scheme and acquired after 1 January 2011 there are different rules. Those rules are set out in the next section of this manual.
There is no discretion to allow tax recovery on services received more than six months before registration unless the effective date of registration is backdated. However, the tribunal has envisaged some discretion to allow recovery in respect of discrete goods that have been acquired not as a supply of goods but incorporated within a single supply of services. See Lai (K&M) (t/a The Rice Bowl) at VIT63200.
Generally, the amount of tax that can be recovered is the amount that would have been deductible had the business been registered at the time the tax was incurred (though an exception to this is explained further below). You should consider partial exemption and non-business restrictions when you calculate the amount of tax to claim. Please note that the partial exemption de minimis limit does not apply to VAT incurred pre-registration.
A business may not use regulation 111 to recover VAT on supplies that were purchased for non-business or private purposes. The expense is not a business cost, and no VAT can ever be recovered, regardless of any subsequent business use. This principle was confirmed in the case of Waterschap Zeeuws Vlaanderen (see VIT62520). For example:
an individual buys a van to use for wholly private purposes. Three years later the individual registers for VAT and uses the van exclusively within their business. The VAT paid on the van is permanently outside of the VAT system because there were no business activities at the time the van was bought. The VAT paid on the van can never be brought back in under the terms of regulation 111.
an unregistered charity acquires a building at a cost of £1M plus VAT. This building is a capital item for VAT purposes. At the time of acquisition, it only expects to use the building for its charitable work. This work is non-business for VAT purposes. If they had been registered at this time, there were no business activities that would have permitted recovery of the VAT as input tax. After three years the charity registers for VAT because it has entered into new contracts that involve the making of business supplies. At the time of registration, the charity may not recover any VAT that it incurred on the acquisition under the terms of regulation 111.
A business may not use regulation 111 to recover tax on goods or services that formed part of onward supplies it made before the effective date of registration.
Pre-registration - capital items on hand when registering from 1 January 2011 onwards
Capital items are defined as:
- Land, buildings and civil engineering work or capital expenditure in relation to the same including construction, refurbishment, fitting out, alteration and extension, where the value is more than £250,000 (Land); or
- Ships, boats or other vessels and aircraft including capital expenditure in relation to the same of construction, refurbishment, fitting out, alteration and extension, where the value is more than £50,000 (Ships and Aircraft); or
- Single items of computer hardware where the value is over £50,000 (Computers).
Where the goods or services acquired prior to registration are capital items and when the business registers on or after 1 January 2011, even in cases where the registration is backdated to an earlier date, the normal regulation 111 time limits of six months for services and four years for goods on hand may not apply. Instead a business may be able to recover VAT incurred up to ten years prior to registration in respect of land and up to five years prior to registration for other capital items.
This treatment will only arise if, at the time of acquisition, the business intended to make some business use of the capital item such as making exempt supplies or taxable supplies below the registration threshold.
To make sure that VAT incurred pre-registration is recovered fairly a business has to adjust the amount of recovery under the Capital Goods Scheme (CGS), subject to the five and ten year limits mentioned earlier. For further information on the CGS see PE Partial Exemption
For example:
- an unregistered charity acquires a building at a cost of £1M plus VAT (a capital item for VAT purposes). At the time of acquisition they only intend to use the building for their charitable work (non-business for VAT purposes). If they had been registered at this time there are no business activities that would have permitted recovery of the VAT as input tax. After five years the charity registers for VAT. At the time of registration the charity is not permitted to recover any VAT under the CGS
- an unregistered business acquires a building at a cost of £1M plus VAT (a capital item for VAT purposes). At the time of acquisition they only use the building for exempt business purposes. If they had been registered at this time there were business activities that would have created input tax. The input tax would have been irrecoverable input tax relating to exempt supplies. After five years the business registers for VAT and starts using the building entirely to make taxable supplies. At the time of registration they are allowed to recover VAT under the CGS.
In the second example the amount of VAT that can be recovered will reflect the exempt use prior to registration. The period of adjustment is ten years, starting from first use of the building. The business registered for VAT five years after acquiring the building and making first use of it. If there are no further changes in use the amount of VAT that can be recovered is 50%. This is recovered by CGS adjustments for each of the next five years. There is no upfront, single VAT recovery.
The CGS adjustments will reflect the actual use of the building in each year if there are further changes in use in the next five years. For more detailed guidance on how to carry out this calculation see PE Partial Exemption
Pre-incorporation
A limited company cannot register for VAT until it is formally incorporated. Goods or services may have been supplied to the employees setting up the company before then.
A company can claim VAT on those goods and services if the tax relates directly to the business to be carried on by it following incorporation and registration for VAT. The six-month limit in respect of services and the four year limit for goods also apply to pre-incorporation claims.
VAT incurred pre-registration can only be claimed to the extent that, at the time the tax was incurred, the relevant goods and services were used, or to be used, to make taxable supplies. Please note that the partial exemption de minimis limit does not apply to VAT incurred pre-registration.
The decisions in Douros (T) (t/a Olympic Financial Services) and Byrd (GN) (t/a GN Byrd & Co) comment on attempts to exploit the provisions of regulation 111. See VIT63200 for details.
Post-deregistration
The right to deduct input tax stops at the date of deregistration. VAT can be reclaimed where services supplied after the date of deregistration relate to the business activity carried on while the business was registered.
This also applies when the deregistered business did not claim input tax to which they were entitled while registered. It does not apply to goods supplied after the date of deregistration. Tax cannot be claimed beyond the capping limit for the period in which it was incurred.
For post-deregistration claims that are submitted on form VAT 427, all completed forms and original documentation should be sent to:
HMRC Payments VAT/CT61
HM Revenue and Customs
BX9 1XD
Original documentation is needed if a claim is to be considered. The capping legislation applies to all VAT 427 claims. Anyone submitting a VAT 427 claim must carry out direct attribution if they made exempt supplies whilst registered for VAT because there is no de minimis limit following deregistration. Therefore any VAT incurred which relates to the making of exempt supplies cannot be claimed. For non-attributable input tax the recoverable proportion applicable immediately prior to deregistration should be used.
Claims for relief on goods on hand are sometimes received from businesses who were previously registered for VAT as the same legal entity. Typically this happens when the turnover of a business falls below the registration limit but later rises above it again.
Output tax will have been due on these assets under VAT Act 1994, Schedule 4, paragraph 8. This is a deemed self-supply when a person ceases to be VAT registered, to ensure that their future consumption of the assets (as a non-taxable person) is properly taxed.
When registering again the business may still have assets on which VAT was claimed as input tax while it was previously registered. If this occurs, and to the extent that the goods are still held and will be used in the new VAT registration, VAT on the deemed supply at deregistration can be considered when establishing an input tax claim under regulation 111.
HMRC accept that where proof that payment of VAT on the deemed supply was made to HMRC on deregistration, this will be accepted as alternative evidence in support of an input tax claim, allowing deduction under regulation 111.
Under regulation 111 a deduction will not be available if outside the time limit specified (four years for goods) or if the goods were not intended for business use at the time of the deemed self-supply on deregistration. The most likely reason for this is that the business ceased altogether at this point.
Regulation 111 does not apply if the asset is a capital item falling within the capital goods scheme (land or buildings costing over £250,000, computer equipment, ships or aircraft costing over £50,000). Instead any input tax deduction must be under the Capital Goods Scheme. For this purpose the cost may be the value of the self-supply or subsequent capital expenditure on the asset while not registered, depending on the circumstances. If the asset is a capital item then the four year limit does not apply. More information on the Capital Goods Scheme can be found in Notice 706/2 Capital Goods Scheme paragraph 13. For pre-registration and pre-incorporation cases the relief is treated as input tax. The tax must be claimed on the first return the business is required to make (not the first return which they do make). A business cannot claim relief on a later return if that return is made after the capping limit for the due date of the first return the business was required to make.
Registration as a result of exempt supplies changing to taxable
From 1 January 2025, supplies of educational services made by a private school will be standard rated, having previously been exempt. As a result, many schools will be registering for VAT for the first time. Goods and services will have been acquired which would have been used for an exempt purpose prior to registration. Under normal deduction rules, even if the school had been registered at the time this VAT was incurred, it would not be deductible. However, HMRC has exercised its discretion to allow some recovery of this VAT, recognising that some goods and services will be used for taxable purposes going forward.
For such goods purchased within four years of registration, and that have been put to use making what would have been exempt supplies if registered, an apportionment will be required to reflect the past exempt use of the goods.
To balance simplicity with accuracy and fairness, HMRC will allow an apportionment assuming an economic life of 5 years, similar to that in Regulation 116C of the VAT Regulations and require a restriction to reflect the exempt use before registration. Recovery will only be allowed to the extent that the remaining economic life after 1 January 2025 is put to taxable use. For future periods, a projection of the expected taxable use will be required.
Below are two examples of how to calculate how much VAT can be recovered.
Example 1
A private school purchases sports equipment with VAT of £1000 for use in lessons on 1 August 2023. It registers for VAT on 1 November 2024 and its first tax year starts on 1 April 2025
Using the 5-year use calculation to split the cost there will be 15 months of use prior to registration and 45 months after.
The £1000 is therefore split into £250 before registration and £750 after.
The use before registration was purely for exempt supplies so no recovery is allowed.
Between registration and the start of the next tax year the equipment will be used for exempt supplies for 2 months (until 1 January 2025) and for wholly taxable supplies for the remaining 3 months before the start of the next tax year. The recovery for post registration use will be £750 x 3/5 = £450.
The total that can be recovered is therefore £0 + £450 = £450.
Example 2
A similar school but with a nursery purchases sports equipment on 1 May 2023. For the first 20 months of the economic life, the equipment will be put to exempt use. From 1 January 2025 until the end of their economic life on 30 April 2028, itis projected to be put to a mix of 75% taxable and 25% exempt use reflecting the primary and nursery classes.
The school will not be able to recover VAT incurred for the months that the goods were put to exempt use. For the months they are to be put to mixed use, the school will be able to recover 75% of the VAT incurred, as the proportion of the use that is taxable. The calculation that the school must perform will therefore be:
(60-20)/60 X 75% (part taxable use). This means 50% of the VAT incurred is recoverable.