How does VAT partial exemption work?

Full answer

Partial exemption applies when a VAT-registered business makes a mix of taxable supplies (standard, reduced or zero-rated) and exempt supplies (such as insurance, finance, betting, certain education, health or land/property without an option to tax). Input VAT is sorted into three pots: directly attributable to taxable supplies (fully recoverable), directly attributable to exempt supplies (not recoverable), and residual or overhead VAT used for both (recovered in proportion). The standard method recovers residual VAT using the fraction taxable turnover divided by total turnover, rounded up to the next whole percent (special rules apply to large businesses). Each VAT return uses a provisional recovery, then an annual adjustment recalculates the year as a whole. The de minimis rule is the key relief: if total exempt input VAT is below GBP 625 per month on average (GBP 7,500 a year) and is no more than half of all input VAT, the business can reclaim all of it as if fully taxable. Many small mixed businesses fall under this and recover everything. Worked example (mechanism): a firm has GBP 800,000 taxable and GBP 200,000 exempt turnover, so residual recovery is 80%. If it incurs GBP 10,000 of residual input VAT, it reclaims GBP 8,000. If its exempt-attributable VAT then exceeds the de minimis limits, that exempt portion is blocked. For 2026/27 the de minimis limits (GBP 7,500/year) and the 20% standard rate are unchanged. Partial exemption interacts with the Capital Goods Scheme for large assets, so review both together. You can apply to HMRC for a 'special method' if the standard turnover-based split is unfair. Use a VAT calculator to model the recovery percentage and check the current method rules on gov.uk.

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