Tax Insight: Partial Exemption Special Methods
Read time: 4 mins
Service: VAT & indirect taxes
Your business may already have a Partial Exemption Special Method (PESM) in place. But could you recover VAT even more efficiently and beneficially?
And could now be the time to review your position, to reflect the way your business works today – and in the future?
Keeping VAT recovery simpleMany businesses – particularly those in insurance-related businesses – employ a PESM: a mechanism that’s designed to identify recoveries of VAT from expenditure (input tax), across a range of sectors and geographical regions.
At its simplest, this is based on the principle of direct attribution, combined with the ratio of qualifying insurance income to total insurance income.
Less costly, less complicatedFor many businesses, the so-called ‘standard method’ of direct attribution plus income based apportionment is the appropriate way to recover VAT. In general, this provides a recovery rate that’s considered fair and reasonable, and based on actual use of expenditure.
However, this ‘standard method’ may not be the most fair and reasonable, or the most beneficial for every business. For an insurance-related business in particular, it can work out costly and difficult to recover exactly the right amount of VAT for every transaction, across activities that may range from writing policies to claims management and property rental.
Make sure you have your sayBusinesses can use the ‘standard method’ without obtaining HMRC permission first. However, if HMRC considers this method is not fair and reasonable for the business in question, it has the power to step in and require you to use a PESM instead.
Following HMRC intervention, you may not have an opportunity to negotiate or influence the terms of a PESM. The consequences for your bottom line could be costly.
That’s why it’s vital to take the initiative and work with an expert who can help you design a PESM appropriate for your business. One that works withthe way you work; helps you benefit from the income you’ve earned; and has the potential to repay you for the considerable extra effort involved in changing systems and training staff.
Your PESM needs to ensure maximum input tax recovery, while also satisfying HMRC that it is fair and reasonable.
Applying for a PESMYou need to apply in writing, setting out full details of the proposed method.
It’s important to get expert input right from the beginning. Your application must be accompanied by a declaration from a director certifying it is fair and reasonable. HMRC will not advise on the structure of a PESM.
Make sure your accounting systems are ready – and stay readyWe can help you ensure that your accounting systems are able to cope with the new requirements of a PESM. Most importantly, there has to be a clear audit trail which HMRC can follow – this may call for off-site and third party accounting systems being adapted, to ensure the correct VAT treatment is adopted for each individual sector in which you’re active.
We can also help you train staff who are involved in inputting core data, so they understand the attribution requirements.
Changing methods for changing businessesIt’s important to remember that a PESM is a living working system. Businesses change over time. It’s vital to make sure your PESM changes too, to reflect the way you do business and allow for future expansion.
If you’re exploring new income streams, new businesses activities, or changes to your corporate structure, such as mergers and acquisitions, these must be reflected in the method you adopt. This is particularly important for holding companies, as recent case law has demonstrated.
Expert advice can make all the differenceIt’s vital to have an expert adviser ready to guide you through the process. PKF has valuable experience of designing PESMs, working together with businesses who need them – and of negotiating with HMRC, to seek the most beneficial terms on your behalf. We can help you keep your PESM under constant review, so it stays beneficial for the business and has the flexibility to accommodate future changes.
Remember, when a business fails to operate and maintain a PESM, it can lead to a tax loss for the business or for HMRC. So it’s good practice to review and update any PESM every four years, at a minimum, both to avoid the risk of HMRC imposing new conditions that may be less beneficial, and to reduce the risk of significant penalties.
We’re keen to show you how we could help structure and design a PESM that’s beneficial for your business, and help keep everyone working with it effectively.
To find out more, please contact us.