Certain types of supply are within the scope of value added tax (VAT) in the UK but are exempted from VAT. The main types of exempt supply for UK value added tax include certain financial services and insurance, health, education and some supplies of land and buildings.
Where a business makes exempt supplies, it cannot reclaim VAT paid (input tax) on expenses connected with those exempt supplies. Where the total input tax on expenses relating to exempt supplies exceeds a minimum level, the business is also required to disallow a proportion of its general overhead expenses as these are also regarded as partly attributable to the making of exempt supplies.
VAT exemption must be distinguished from zero rating. Where a supply is zero rated, it is a taxable supply for VAT purposes, but the rate of VAT on the supply is currently zero. A supplier making zero rated sales does not add any VAT to those sales but has the right to recover VAT input tax paid on purchases and expenses incurred in connection with those sales. A supplier making exempt sales cannot recover the input tax relating to the exempt sales.
Supplies that are exempt from VAT may not be so favourable for the final customer as zero rated supplies. Where a supply is VAT exempt, the final customer (an individual or an unregistered business) does not need to pay VAT on the supply. However as the supplier is unable to recover the input tax relating to the expenses incurred in making the supply, this may be reflected in the price charged to the final customer. This price may contain hidden VAT in the form of a price adjustment to cover the cost of the irrecoverable input tax.
Exemptions for financial services and insurance
Exempt financial services include dealings in money, loans and credit, hire purchase and credit sale agreements, option and documentation fees in hire purchase and credit sale agreements and commission on these transactions (e.g. services of mortgage brokers in arranging loans and services of building societies in arranging mortgages and investments). Also exempt are underwriting fees on the previously mentioned transactions. Many activities of banks and building societies will therefore be VAT exempt, but some other activities such as advisory and consulting services will be subject to VAT at the standard rate.
Insurance and reinsurance transactions are also VAT exempt. Insurance companies will perform some transactions, such as advisory services, that are subject to VAT and they will need to perform careful VAT administration to distinguish between exempt and taxable transactions. There is also an insurance premium tax in the UK with rates of tax that are similar to the VAT rates, so insurance companies must also account for and pay over the insurance premium tax.
VAT exemption for land
Certain transactions in land are VAT exempt. The VAT exemption covers “the grant of any interest in, right over or any licence to occupy land”. However there are some exceptions to this. The sale of the freehold in commercial buildings is standard rated for VAT if the building is sold during construction or within three years of being completed (a new commercial building), and hotel accommodation is also standard rated.
If the business selling land or the freehold of a new commercial building wants to avoid irrecoverable input tax it can exercise the option to waive exemption (also called the option to tax) and charge VAT on the transaction at the standard rate. In practice the buyer will need to be consulted before this is done.
VAT exempt educational services
Education and vocational training are both VAT exempt if they are supplied by an eligible body. The definition of an eligible body includes schools, colleges, universities, government bodies, local authorities and charities. In the case of charities, they must plough back profits into the education (rather than distributing profits) if they are to be considered an eligible body for the purpose of the VAT exemption.
Although the word “education” is not defined in the VAT legislation, HM Revenue and Customs guidance suggests that education includes a course, class or lesson in any subject whether or not it is normally taught in schools or colleges and wherever it takes place. Education therefore includes lectures, seminars, conferences, recreational courses and distance learning.
VAT exempt health services
The services of doctors, nurses, dentists and other medically qualified people are VAT exempt, where these are services in the relevant field of health for which the person is qualified and are related to the health of patients. The VAT exemption relates to medical services and not to the drugs dispensed. The drugs that are dispensed under the health service (NHS) are zero rated and drugs dispensed under private prescriptions are subject to the standard rate of VAT.
Charges made by hospitals to patients for medical care or for medical or surgical treatment, and any supplies of goods connected to this, are VAT exempt. Care is defined by HMRC as the protection, care and guidance of the individual in meeting their medical needs, usually involving personal contact with the individual.
Other VAT exemptions
Other exemptions include postal services, betting and lotteries and cultural services such as admission fees for museums and art galleries. Burial and cremation fees are also VAT exempt.
Fund raising events by charities and certain other organisations are VAT exempt, subject to strict conditions. This exemption covers individual events such as sports competitions, and is limited to fifteen such events per year of the same type in the same location. In addition to charities, this exemption can apply to certain non-profit making organisations supplying facilities for sport or pursuing political or religious aims.
HM Revenue and Customs www.hmrc.gov.uk
“Value added tax” by Andrew Needham and Steve Allen, Bloomsbury Professional, 2009