VAT Partial Exemption and Capital Goods Scheme

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VAT Partial Exemption and Capital

Goods Scheme

Summary of responses

23 March 2021

 
 
2 
 
Contents 
VAT Partial Exemption and Capital Goods Scheme ....................................................... 1 
Summary of responses ................................................................................................... 1 
1. Introduction ................................................................................................................. 3 
2. Responses .................................................................................................................. 4 
Partial Exemption Special Methods (PESMs) .............................................................. 4 
PE De minimis ............................................................................................................. 6 
Capital Goods Scheme ................................................................................................ 7 
Other suggestions ........................................................................................................ 9 
3. Next steps ................................................................................................................. 11 
Changes to Internal Processes .................................................................................. 11 
Further stakeholder engagement ............................................................................... 11 
Annexe A: List of organisations and stakeholders who responded to the call for 
evidence ........................................................................................................................ 12 
 

1. Introduction

Businesses that make both taxable and exempt supplies (‘partial exemption’) incur VAT

on their purchases that cannot be attributed directly to either taxable or exempt

supplies. A calculation must be performed to determine how much of this VAT is

recoverable. There is a standard method for working that out, but if the standard method

does not provide a fair and reasonable result, businesses can use a Partial Exemption

Special Method (PESM). A PESM allows a bespoke calculation for a business to

determine its recoverable VAT.

The Capital Goods Scheme (CGS) provides for adjustments to be made over time to

the initial VAT recovery relating to purchases of certain capital items (such as buildings,

computers and aircraft), recognising the longer working life such assets have. The

recovery of the VAT incurred on such assets is only made once – in the year of

purchase. If, during the life of the CGS, there is any change in the proportion of taxable

use then businesses must make an adjustment to their recovery of VAT to take account

of this.

In July 2019 the government launched a call for evidence on the simplification of the

Partial Exemption (PE) and Capital Goods Scheme (CGS) regime. Announced at Spring

Statement 2019, it looked at ways to improve the operation of PE and the CGS,

following the findings of the 2017 Office of Tax Simplification (OTS) VAT review. The

call for evidence was intended to gather evidence and views on three distinct areas:

• Simplification of the PE Special Methods (PESMs) approvals system.

• The PE de minimis test and thresholds.

• Changes to the CGS thresholds for land and property and associated alterations,

extensions, annexes and refurbishments. The call for evidence also considered

the administration and scope of the CGS.

This document is a summary of the 80 responses received to the call for evidence. Over

half of the responses were from businesses. The majority of the rest were from trade

organisations, advisors and public sector organisations.

In addition to written responses, four multi-stakeholder meetings were held with relevant

stakeholders including trade associations and accountancy firms. The government is

grateful to all those who took the time to respond.

Where responses were received which covered subjects outside the scope of the call

for evidence, these were noted and may be considered as part of any future reviews of

this area.

For the government response to the comments received to the questions in this call for

evidence, please see the ‘Next Steps’ at the end of this document.

2. Responses

Partial Exemption Special Methods (PESMs)

This section of the call for evidence focused on the process of getting an approval for a

Partial Exemption Special Method (PESM) and how that could be simplified. At present

where a business requires a PESM, it must submit a proposal with a signed declaration

that the proposal is, in its view, fair and reasonable. This proposal will be reviewed by

HMRC and, if appropriate, approval given for its use following checks on the proposed

method.

Question 1 ”Does your business use a PESM? If so, what was your experience in

getting the PESM approved?”

Nearly all respondents had experience of using a PESM, including those responding on

behalf of members or clients.

Experiences of agreeing PESMs were mixed, over half of respondents noting that the

length of time it takes to agree a PESM is excessive. In addition, a third of those also

described the process as either difficult, challenging, onerous or frustrating, for example

because of the time taken for approval to be granted or a perceived lack of clarity about

what was required. Please also see response to Q3

These views were similar to those expressed in stakeholder meetings where the main

issue was highlighted as excessive time taken to agree a PESM.

Question 2 “How long did the approval process take”

There were a range of responses to this question, from less than six months to over two

years. Of those responding on behalf of others, some stated that it varied depending on

the complexity of the business. Overall, most respondents felt it was excessive. The

same views were shared in stakeholder meetings.

Question 3 “Do you find the administration involved with PESMs challenging?”

Of those that addressed the question the majority felt that the administration involved

with PESMs was challenging. Respondents stated that it depends on the complexity of

the PESM, but also that HMRC’s attitude could make the process challenging. The

reasons given for why it was challenging varied from HMRC’s lack of commercial

understanding of certain sectors to respondent’s lack of understanding of the process

and information required and this increased the length of time spent in negotiating with

HMRC.

Question 4 "Would allowing businesses to apply PESMs without seeking approval

improve the system? Please give reasons for your answer."

Question 5 "Would there be issues created by removing the requirement to seek

approval of a PESM?"

These questions are considered together as most respondents answered them in that

way.

A range of views were expressed in response to these questions. Around half of

respondents felt that enabling businesses to apply PESMs without seeking approval

could simplify and improve the system. This view was also expressed at stakeholder

meetings. Some respondents felt this would end uncertainty during the existing

approvals process. An example given was larger businesses are constantly changing in

nature, so they cannot always agree a PESM for the whole of the business up front, and

this therefore creates uncertainty for a longer period of time. Using a PESM without

approval would remove this uncertainty.

Respondents also identified potential changes that they thought would help if the

approvals system was removed. These included clear rules about which PESMs HMRC

can challenge, if HMRC move away from approvals and require simple notification of

the intended use of a PESM; a timeframe for HMRC to respond to a PESM notification;

and sectoral frameworks and improved guidance.

Over half of the responses included concerns with removing the approvals process, as it

could reduce business certainty, and businesses could be at risk of future assessments

and penalties. Respondents stated that there could be an optional approvals process for

businesses that require the legal certainty that comes with HMRC approval.

Question 6 "Would an increased focus on the use of sectoral frameworks be of

benefit, particularly if approvals were removed?"

The majority of respondents were in favour of increased focus on sectoral frameworks.

However, respondents indicated that these frameworks should be optional, flexible, and

should be developed in partnership with industry experts.

This view was also expressed in stakeholder meetings, with the suggestion that these

frameworks could be used as ‘off the shelf PESMs’, provided they were not prescriptive.

Question 7 "Do you have other suggestions to improve or simplify the application

of the PE regime?"

There were a number of industry or business specific suggestions made by attendees at

the meetings and respondents to the call for evidence. This included the ability to

amend a PESM that is currently in use without having to agree the entire method again

as is currently the case. Another suggestion was where PESMs comprise sectors that

are all utilising turnover-based VAT recovery calculations, it would be reasonable to

permit these to be applied without prior HMRC approval, as they are essentially a

consolidation of multiple standard methods calculations.

Question 8 “Do you have other suggestions on how the way in which HMRC

interacts with partly exempt businesses could be improved?”

There were a variety of responses to this question, ranging from concerns about HMRC

expertise to those about how HMRC engages with businesses. Respondents suggested

more training for local officers and for PE specialists to speak directly to taxpayers and

be involved earlier on in the approvals process. It was also suggested that HMRC staff

should develop more commercial awareness (a point also echoed at stakeholder

meetings). Respondents also suggested further guidance in the form of a checklist or a

template about what is required to apply for a PESM would be useful.

PE De minimis

This section of the call for evidence focused on the PE de minimis test and how that

could be simplified. Views were sought in respect of removal of the de minimis test and

raising the threshold at which businesses would have to conduct a full PE calculation.

If a business meets the PE de minimis test, it enables the business to recover all input

tax that relates to exempt supplies as well as their taxable supplies. Currently a

business is de minimis if exempt input tax is not more than £7,500 a year (£625 a month

on average) and is less than half of the business’s total input tax in the relevant period.

Question 9 "What is your experience of carrying out the de minimis test?"

Responses to this question were mixed. Respondents stated that the test was complex

and takes considerable effort and time, however they also thought that the de minimis

test is a valuable simplification for businesses. This view was expressed in stakeholder

meetings, with attendees stating that the de minimis test was a good facilitation for

small businesses and that it should be retained, however they also thought that the

threshold should be increased.

Question 10 "What would the advantages and disadvantages of increasing the de

minimis threshold be to business?"

Many respondents stated that increasing the de minimis threshold would be an

advantage, as it would assist smaller business with greater input tax recovery; ease the

administrative burden and remove uncertainty for those on the threshold. It would also

take some businesses out of the current PE requirements and encourage more

voluntary registrations for those below the current VAT registration limit.

Many respondents were in favour of an increase to the de minimis threshold and most

of these were in favour of an increase in line with inflation at the very least.

Some respondents identified potential disadvantages to increasing the de minimis

threshold. A higher limit could create more of a ‘cliff edge’ for those who would no

longer be able to benefit from the de minimis as they approach the threshold and could

potentially disincentivise business growth. Increasing the threshold could also create

more of an administrative burden for HMRC and businesses on the edge of the

threshold

Question 11 "Are you aware of the existing simplification, and do you make use

of it?"

Only a small number of respondents were aware of the de minimis simplification, with

fewer respondents making use of it.

Question 12 "What would be the advantages and disadvantages of removing the

de minimis test?"

Many respondents stated that the removal of the de minimis test would be a

disadvantage, as it would force more smaller businesses into PE, requiring them to

perform full PE calculations; increase administrative and financial burdens for

businesses; and would also have an impact on not-for-profit organisations.

Q13 "Do you have other suggestions to improve or simplify the application of the

de minimis regime?"

Some respondents suggested a change in the way that the de minimis is

calculated.

Q14 "Do you have any suggestions on how to determine what can be considered

as ‘insignificant’ that would be different to the current de minimis tests?"

Suggestions included a fixed percentage of turnover (less than 1% for example) or

using a transaction count or number of instances.

Capital Goods Scheme

This section of the call for evidence focused on the CGS and how it could be simplified.

Views were sought on proposals to increase the threshold for land and property and

associated alterations, extensions, annexes and refurbishments. The call for evidence

also considered removal of computers from the CGS and a change in the number of

intervals.

Q 15 "What is your experience of the CGS?"

The most common response was that the CGS is burdensome, complex, and results in

minimal adjustments. Some respondents indicated that the CGS is not well known or

understood.

Q 16 "How much time and resource do you allocate to carrying out CGS

calculations? Does this have an impact on your business?"

Most respondents stated that they had to allocate a significant amount of time to carry

out these calculations, which has an impact on their businesses. They also indicated

that the CGS uses specialist resource to complete (in-house or external specialists),

and that it takes considerable time to compute the initial calculations. Respondents

noted that the high number of qualifying refurbishments/extensions was an issue.

Q 17 "To what extent does the CGS help to prevent cases of tax avoidance and

unfair competition?"

Some respondents answered that they did not know or didn’t view CGS as an anti-

avoidance matter. A small number of respondents answered that CGS was an effective

anti-avoidance measure, and that it helped prevent competitive advantage.

Q 18 "What would be the advantages and disadvantages of increasing the

threshold for land and property for businesses?"

Most respondents indicated that the threshold should be increased, with mixed views on

the advantages and disadvantages of doing so. The main view was that it would reduce

the number of qualifying assets falling under CGS, simplifying internal record keeping

and reducing the administrative burden on businesses. However, respondents also

stated the disadvantages, which include some taxpayers (and HMRC) losing out from

future changes in usage and the VAT resulting, if they were not under the CGS

mechanism.

Many respondents did not specify a specific value for the increase, although links to

indexation and inflation were suggested. Some respondents specifically stated £1

million, again with many requesting indexing going forward or regular reviews. A smaller

number of respondents suggested a value of between £2.5 million and £5 million.

The stakeholder meetings included similar discussions to the above. The general view

was that an initial increase would be welcome, followed by regular reviews and

increases in the future. Stakeholders also wanted any increases to be based on the

economic life of assets. Suggestions ranged from doubling the current threshold to

raising it to £2.5 million

Q 19 "Would there be any other issues involved with increasing the land and

property threshold?"

Respondents answered that there could be transitional issues resulting from any

increase, with the primary concern being developments/refurbishments that straddled

any change in threshold and how these assets would be treated going forward.

Q 20 "If the threshold for land and property is increased, do you think we should

consider having a different threshold for alterations, extensions, annexes and

refurbishments, (i.e. retain the current threshold) or would this increase

complexity?

Many respondents were of the view that any difference in thresholds would not be a

simplification but would result in an increase in complexity, making the CGS harder to

administer. Although other respondents supported different thresholds, they recognised

that this would increase complexity.

The consensus within stakeholder meetings was that having differing thresholds would

increase complexity, and therefore should not be considered.

Q 21 "Are there other ways in which the CGS can be improved?"

There were a number of other suggestions to improve the CGS. The most common

suggestion was to have a form of de minimis for CGS. Respondents also stated that

they would like better guidance on the application of CGS special methods. There were

a small number of responses on the scope of the CGS, with respondents stating that

yachts/aircraft should be removed from CGS altogether. Stakeholders also suggested

the alignment of the CGS interval adjustments with the PE years (at present businesses

account for the CGS adjustment in the subsequent VAT return to the PE annual

adjustment). In addition, the proposal was made to align the CGS with normal VAT

record-keeping requirements (for CGS purposes, businesses need to keep records for

10 years, whereas for normal VAT requirements they only need to keep records for six

years)

Q 22 "Do you have experience of computers being included in the CGS?"

Of the respondents who answered this question, a very small number had experience of

computers being included in the CGS.

Q 23 "Would removing computers from the CGS be a simplification for

business?"

A majority of respondents agreed that computers should be removed from the scope of

the CGS, whilst recognising it would have a limited effect on simplification.

Q 24 "What do you think of the current interval length?"

Respondents were generally of the view that the current intervals were appropriate. A

few respondents suggested intervals ranging from five to 20 years.

Q 25 "Would a change in the number of intervals help businesses with their

administration of VAT? Why? "

Many respondents answered that a change in the number of intervals would help

businesses with their administration of VAT, specifically helping with the Transfer of

Going Concern record keeping requirements. A small number of respondents stated

that they were satisfied with the current methodology and its application.

Other suggestions

This part of the call for evidence invited any other suggestions for improving and

simplifying the PE regime and the associated CGS.

Q26 "Do you have other suggestions to improve and simplify the application of

the PE and CGS regime?" (excluding points already raised)

There were various suggestions put forward in response to this question, including

improved light touch principles and more frameworks, simplification of business/non-

business calculations, and dispensation for clubs, charities and voluntary organisations.

Respondents would also like to understand the position of leases regarding CGS

terminations. Another suggestion was an opt-in system for carrying out full PE

calculations. For example, where recovery is below 15%, businesses should be able to

apply a specific percentage to the total input tax without any attribution.

Other responses included a reduction of the scope for exemption; limiting the CGS to

single capital purchases over £1 million; a single VAT adjustment for CGS in year 10 of

the intervals (or two five-year adjustments); simplification of rules before incorporating

any changes into Maxing Tax Digital; and improved HMRC guidance.

Q27 "Do you have any experience of the operation of PE and the CGS in other

countries?

Respondents gave the following examples of PE/CGS regimes (or equivalent) in other

countries:

• Germany has no formal PESM approval process, however options for use of

proxies within methods are limited.

• In Ireland VAT groups operate a sectorised method based on concessionary

treatment of fund managers, allowing a review but not requiring PESM approval.

• Australia has a very high de minimis threshold £250k and a multi-tiered system of

input tax recovery.

• Canada has a special refund scheme for the not-for-profit sector.

• Singapore publishes recovery percentages for sectors yearly.

• Some EU Member States either have a single residual pot or provide sector flat

recovery rates

Respondents stated that the schemes in other jurisdictions are generally simpler but

less flexible, and that thresholds are reviewed and updated more frequently than in the

UK.

The general view was that the UK has a very flexible regime. Respondents stated that

this flexible approach is appreciated and should be retained, but that this can

sometimes lead to protracted approvals. Respondents also noted that the UK has a

very low exemption threshold in comparison to other countries, which means more

businesses fall under PE rules.

29 "Do you have any other comments?"

There were no discernible recurring themes in response to this question. However, a

few participants restated the need for better guidance.

3. Next steps

Changes to Internal Processes

Having evaluated these responses, an internal review was carried out to assess the

process for applying for a PESM and how this can be simplified. HMRC will make the

following changes shortly to simplify the current system:

- Centralised application point

There will be a centralised application point for PESM applications set up shortly.

This means that all PESMs will go to the same HMRC team in the first instance and

they can be recorded promptly. This will provide clarity for taxpayers as to the

correct place to submit their PESM application Additionally, this will reduce the time

taken for HMRC to begin reviewing a PESM application.

- Clearer application process

In order to apply for a PESM, there will be an accompanying application form to

complete. The form will guide applicants through the steps of applying and make it

clear what information is required. This will minimise the need for ongoing

information requests from HMRC and should reduce the time needed for HMRC to

process an application. A PESM will only be processed once all the information

required has been provided.

- Sectoral Frameworks

The review of all current frameworks is ongoing, with some now completed. An

internal review to identify the need for new frameworks is also being carried out and

we intend to engage with relevant stakeholders in taking this forward. HMRC are

also in the process of reviewing and updating our existing PE and CGS guidance.

Further stakeholder engagement

The government is grateful for the informative responses to this call for evidence. These

responses have illustrated a range of views and concerns, including specific changes

which could be made to simplify the PE regime and the associated CGS.

The changes to internal processes outlined above are intended as a first step to

address the concerns expressed about the current PE regime. HMRC will be engaging

with stakeholders in due course to evaluate the impact of those changes and the extent

to which they have simplified the process for business. As part of that engagement,

HMRC will also keep under review the need and potential for further changes.

In terms of the de minimis and CGS, HMRC will also engage further with stakeholders

to better understand the impact of any potential threshold and process changes which

could be made in the future.

Annexe A: List of organisations and

stakeholders who responded to the call

for evidence

The respondents to this call for evidence were:

ABI

Aria Resorts

Ashfield Park Homes

Aviva

AXA

BDO

BHHPA

British Property Federation

Brickhill Park

BUFDG

Burke Enterprises Ltd

Buzzacott LLP

Coswawes Park

CBRE LTD

Charity Tax Group

CIOT -ATT

Clock Caravan Park

Creek Caravan Park

Deloittes

DWP Tax centre of excellence

England Golf

FLA

FODO

Gainsborough Park

Haulfryn

Helle Valley Holiday Park

Helford Sailing Club

Hoo Ness Sailing Club

Hurley Riverside Park

ICAS

ICAEW Tax Faculty

ILAG

Investment Association

IUA

KPMG

Lang & Horgan LTD

LIIBA

Lloyds Banking

Markel Tax

NCHA

Netleys

NFU

Oaklands Grange Caravan Park

Orchards park

PCSW LTD

Pettycur Bay

Pioneer Caravans

Places for People Group

Public bodies group and charities

PWC

Quiet site

Resiparks.co.uk

Royal Mail

Royal Northern & Clyde Sailing Club

Royal Solent Yacht club

Royal Yachting Association

Salterspetfood

Scotchwell Park

Sport & Recreation Alliance

Strood Yacht Club

Tenby Sailing Club

Thames Motor Yacht Club

Tomlinson’s Leisure Park

Tudor Sailing Club

UK Finance

VAT in Industry Group

VAT Practitioners Group

West Kirby Sailing Club

West Lancashire Yacht Club

Woodhouse Farm Caravan Park

Woodside Caravan Park

X-VAT Ltd

YFM Equity