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Can a client claim back VAT for exempt supplies?

Q: My client’s business provides both taxable and exempt supplies. They incur input tax and I know that we can get the VAT back in relation to the taxable supplies but what about the exempt supplies?

A: As a general principal, VAT is only recoverable by a VAT registered business to the extent it relates to taxable (i.e. zero, reduced or standard-rated) income. Normally therefore, where a particular VAT-bearing cost relates wholly to an exempt income stream, the VAT is not recoverable at all; where it relates partly to taxable and partly to exempt income streams (for example many overhead type costs) the VAT is partly recoverable; where it relates wholly to taxable income stream, the VAT is fully recoverable (subject to the normal rules about being the recipient of the supply, holding valid VAT invoices etc.).

If, however, the level of VAT relating to exempt income is small enough (less than £625 VAT a month on average), the business may pass one of the three “de minimis” tests thereby meaning it can recover all its VAT in the normal way (as if it had only taxable income).