VAT on fintech Start-Ups - be aware of the Partial Exemption for VAT

VAT on Startups 

More often than not, UK technology start-ups are quite simple for VAT as their supplies are fully taxable as either a standard or zero-rated supply. In these instances, the decision to register for VAT from the outset tends to make sense as you can reclaim VAT refunds as your business incurs losses during the product development staging of your business lifecycle. 

However, if you are building a fintech business, your world is likely more complex, as you need to be aware of what parts of the financial services sector your business serves. Many financial services businesses are exempt from VAT and as such cannot charge or reclaim any input VAT. 

This article considers the partial exempt scenario where you need to consider whether or not you need to operate a hybrid VAT model. This means that some of your services are exempt from VAT, whereas other parts of your revenue-generating fees and payments are subject to VAT.  

If this situation applies to your business, you may need to make partial exemption calculations because your business makes taxable and VAT-exempt supplies. If you do not, you may attract hefty HMRC penalties and fines. 

Partial exemption (partially exempt) 

Your business is deemed partially exempt if you make taxable as well as exempt supplies for VAT purposes. If you make exempt supplies, your risk falling into these two pitfalls: 

• You cannot charge output VAT. 
• You cannot reclaim input VAT. 

However, the partial exemption calculation will help you determine the extent you can claim VAT on costs – it shows how you use your VAT on purchases to make sales. 

How to calculate claimable input VAT  

To calculate how much input VAT you can claim, follow these three steps: 

Step 1: Direct attribution of input tax

The first step is identifying the VAT incurred on purchases that you use or intend to use exclusively to make: 

• Taxable supplies or other supplies that carry the right to deduct 
• Exempt supplies 

Note – your bookkeeping processes will need to track the purchases that directly relate to each of the above revenue streams. 

Step 2: Apportionment of residual input tax

Like any business, you will have other purchases that cannot be directly attributed to either your exempt or taxable revenues. 

Step 3: Completion of an annual adjustment

From steps 1 & 2 you should have then identified the relevant costs that fall into 3 categories where you will need to treat the input VAT on purchases in the following way: 

• Purchases that directly relate to exempt supplies – not input VAT can be claimed on these purchases 
• Purchases that directly relate to taxable supplies – all input VAT can be claimed on these purchases, subject to other VAT legislation allowing you to do so. 
• Residual Purchases that could not be directly assigned the exempt or taxable turnover – your bookkeeping records should reclaim all VAT in the same way as your taxable turnover transaction by transaction. You will then need to restrict the input VAT on this portion of your purchases when submitting your return – the calculations and process for this restrict is detailed in the section below. 

How to restrict your residual purchase for partially exempt/recoverable VAT 

There are two main ways you can use to distribute partially recoverable VAT: 

• Standard 
• Special methods 

Standard method

The recoverable percentage of residual input tax is determined using this HMRC calculation: 

• Take the value of taxable supplies in the VAT period (excluding VAT) 
• Divide that value by the total value of supplies in the period (excluding VAT) 
• Multiply your answer by 100%

If the standard method does not produce a fair and reasonable deduction of input tax, you must use the standard method override to adjust. Read more about this adjustment on HMRC’s VAT notice. 

Special methods

You can only use the special methods to calculate how much of your input tax you may recover if approved by HMRC. The method will be unique to your business and can contain any calculations or stages that are needed to make sure the calculation is fair and reasonable. 

To apply for the special methods or change to a new one, contact HMRC via: 

• Online 
• Email – PESM@hmrc.gov.uk 
• Write to HMRC and address the letter to: BT VAT, HM Revenue and Customs, BX9 1WR, United Kingdom. 

The de minimis rule 

If your business has insignificant (based off simplified or annual de minimis tests) exempt input tax, the rule allows you to treat it as if it were taxable input tax and recover it in full. Your exempt input tax should not exceed: 

• An average of £625 per month. 
• Half of your total input tax in the relevant period. 

Need further guidance? 

You can read more about VAT partial exemption on HMRCs (VAT Notice 706). 

You can also contact us for VAT advice, accounting and bookkeeping services.