PE32500 - Partial Exemption methods: the standard method override
Outline on how the override operates
Residual input tax and the override
What if the override adjustments are needed year after year?
Introduction to the override
The Standard Method Override (override) was announced in the Budget on 17 April 2002 and took effect from the following day. It is designed to prevent VAT avoidance based on the standard method, although it also deals with situations where the standard method breaks down.
Other than businesses using partial exemption avoidance schemes, very few businesses will be affected by the override and of those that are affected they will be just as likely to benefit as to lose.
Outline on how the override operates
In outline, the override requires a business to adjust the amount of VAT recovered using the standard method where it would otherwise be substantially different from a deduction based on the ‘use or intended use’ of purchases. This comparison is prepared at the end of the longer period, and any resulting VAT adjustment is made at the same time as the longer period adjustment.
The onus to make an override adjustment lies with the business. However, where an override adjustment was required, but the business has not made one, or has done so inappropriately, then an assessment should be raised. A regional PESO must be consulted before any override assessments are issued.
Principle behind the override
| A business will only be subject to the override if… | and… | and… |
|---|---|---|
| they are partly exempt and use the standard method; | their residual input tax is more than £50,000 per year (£25,000 per year for group undertakings not members of the same VAT group) pro rate for periods of less than a year; | the standard method does not give a result that is a fair and reasonable reflection of use or intended use of purchases. |
Even then, the business will only have to make an adjustment if there is a substantial difference between the input tax deducted and the amount deductible given the extent to which purchases are used or will be used to make taxable supplies.
| A difference is substantial if it exceeds… | or… |
|---|---|
| £50,000; | 50% of the residual input tax incurred and is at least £25,000. |
Residual input tax and the override
The override applies to any input tax within the scope of the standard method, except that already recovered on the basis of use. Since 1 April 2009, the standard method has dealt with input tax on all supplies unless it is dealt with separately under regulation 103A (Investment Gold).
The standard method determines what proportion of this residual input tax relates to taxable supplies and is therefore deductible.
The override does not deal with residual input tax that in part relates to supplies described in items 1 and 6 of Group 5 of Schedule 9 to the VATA 1994 (mainly supplies of financial instruments such as shares and bonds). They are catered for by the standard method but are excluded from the values-based calculation, irrespective of their place of supply. The input tax relating to these supplies is ring-fenced and recovered on the basis of use without the application of the override.
The override is not concerned with directly attributable input tax; any misclassification errors are not part of an override adjustment.
What is meant by use?
It is a common misconception that a business must determine a use-based calculation in order to prove that an override adjustment is not needed - this is not true. All businesses that exceed the limits for when the override may apply should consider their position. In most cases the standard method will by definition provide for a fair and reasonable deduction based on the use or intended use of purchases, and the starting point should be to consider whether or not this is the case.
When does the standard method reflect use?
The standard method provides for a fair and reasonable deduction on the basis of use (but not intended use) where residual inputs are used:
- to make supplies in the same period in which the inputs are incurred;
- in proportion to the values of supplies made in the period; and
- to make all of the supplies whose values are included in the standard method pro rata calculation.
Where based on a fair and reasonable assessment of the facts the above questions are answered in the affirmative, a use-based calculation will not be needed for inputs actually used.
What if the override adjustments are needed year after year?
Assuming the quantitative limits continue to be met, the override will continue to apply as long as any business remains on the standard method. However, regular use of the override may indicate that the standard method is not suitable for the business and that a special method may be needed (see PE33000 - Introduction to Special Methods). Whenever a business is known to have had to make adjustments repeatedly the possibility of agreeing a special method must be considered.